The Most Interesting Thing Tim Read This Week: July 25, 2025
Revisiting the Interest Rate Effects of Federal Debt by the Dallas Fed.
The most interesting thing I read this week was “Revisiting the Interest Rate Effects of Federal Debt” which is a Dallas Fed working paper updated this month. The paper estimates that for every 1% rise in debt to GDP, long-term interest rates will rise by 3 basis points. That doesn’t sound too daunting until you consider that the CBO estimates that debt to GDP will rise by 20% over the next ten years and thereby suggests 60bps of higher borrowing costs over the next ten years. Two excerpts from the paper:
“Debt to GDP was relatively stable from 1975 to 2005, averaging 36% of GDP. Since then it has risen to 100% of GDP, and by 2055 it is projected to climb to 156% of GDP according to the January 2025 report.”
“Our findings…underscore the importance of fiscal sustainability for long-term borrowing costs…our estimates indicate that the projected 56 percentage point increase in federal debt over the next thirty years would raise long-term interest rates by about 170 basis points.”
Our view and the Wall Street consensus view is that our fiscal excess is a significant driver of the current strong market returns. We have printed trillions of dollars that have flowed and continue to flow into markets. As we have written many times, our profligacy is unsustainable and invariably there is a payback. Bridgewater’s Ray Dalio said this week, “If the US doesn’t cut the deficit to 3% of GDP, and soon, we risk facing an economic heart attack in the next three years.” That may be a bit hyperbolic, and we should always remember that even legendary billionaire hedge fund managers don’t know the future. That said, what we know is that valuations are at historical extremes and the political reality is that the fiscal spending tailwinds are unlikely to reverse. Therefore, the risk is that borrowing rates could soon become increasingly volatile and problematic.
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