In February 2023, the Congressional Budget Office (CBO) released its updated budget and economic projections. In some respects, most just glanced over these projections and moved on, but if you dig deeper into the data there are some real eye-opening numbers regarding the projected debt and interest expense of the United States.
In 2022, interest expense on the outstanding debt of the United States rose by 35% to $475 billion. Mostly, the increase was due to a rise in interest rates throughout 2022. 2023 has not been any more kind with interest rates rising to the highest levels in nearly 20 years, which will put even more pressure on the annual interest expense for the U.S. as lower cost debt is refinanced.
The CBO had projected annual interest expense would rise to $640 billion in 2023 and $739 billion in 2024. As of the end of October 2023, the annual interest expense on U.S. debt is running at a rate of about $800 billion, significantly higher than the CBO projected earlier this year. The increase is due to higher interest rates and a significant increase in outstanding debt. From 2020-2023, outstanding debt increased by $9.5 trillion to $33.8 trillion due to significant deficits to fund pandemic relief and other government programs.
The average interest rate the Federal Government is paying on debt is trending upwards. At the end of the second quarter 2020, the average interest on outstanding debt was 1.945%, according to the St. Louis Federal Reserve. That has since risen to 2.813% as of the end of the third quarter of this year. To put into perspective how rising interest expense is becoming a burden on the U.S. Government, it is now the fourth largest expense item for the Federal Government behind only Social Security, Medicare and Defense spending. The CBO projects that by 2033, annual interest expense will exceed $1.4 trillion and become the third largest expense, exceeded only by Social Security and Medicare.
Clearly, the United States has a debt problem. Difficult decisions in Washington must be made, which could include decreases in entitlement programs and/or increasing taxes. Rising rates and large fiscal deficits will continue to haunt the U.S. Treasury market, resulting in higher volatility in interest rates. Despite these issues, U.S. Treasuries remain the bellwether fixed income securities across the globe, which is unlikely to change. Maintaining an allocation to bonds, and in many cases alternatives, in portfolios can lead to lower overall portfolio volatility in the long-term. With interest rates remaining near multi-decade highs, fixed income holdings, including U.S. Treasuries, are poised to contribute more materially to portfolio returns than they have in the recent past. Contact your Ancora team to discuss the positioning of your fixed income portfolio in light of this environment.