Stanley Druckenmiller on Squawk Box this morning asked the question on many minds lately: why is the Fed so itchy to cut rates?
Inflation, after all, has done a U-turn higher over the past six months. Leading indicators like jobless claims are still showing strength. So why did they pull back on quantitative tightening at their last meeting, and suggest that rate cuts should still be on the way?
One rather insidious suggestion--which more investors are becoming concerned about--is that they are doing so in order to keep the fiscal situation from spiraling out of control. To bail out the Treasury Department, in other words. Here's why: when the Fed cuts rates, the Treasury doesn't have to pay as much in interest on the federal debt.
That's starting to matter more and more, as even The Economist highlighted in this week's issue. If the Fed cut rates by 1.5 points this year, the Treasury would only pay $1.2 trillion in interest (by Bank of America's calculations). But if they hold rates steady, interest payments would instead cost $1.6 trillion this year--adding a full point to the currently wide deficit. In March alone, as Bloomberg noted yesterday, Treasury paid out $89 billion in interest, or "roughly $2 million a minute."
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And those higher interest costs come at the same time that expected revenues are falling short. Last Monday, Treasury boosted its current quarter borrowing needs to $243 billion from its $202 billion previous estimate, citing "lower cash receipts." The deficit has been averaging around 9% of GDP in recent years--a shockingly high sum that was only previously hit in the middle of massive economic downturns.
The deficit, in other words, is already as bad in the boom years as it used to be in the bust years. So where does that leave us in the next recession? Will Treasury be able to launch stimulus programs? Will interest rates remain stubbornly high? And even outside of that, what happens to the demands an aging population will place on the programs (Medicare and Social Security) that are already the biggest portion of government spending?
As The Economist notes, at least in the 1990s--the last time major "austerity" was put in place--politicians could lean on massive cuts to defense thanks to the post-Cold War "peace dividend." But now, we have both hot wars (in Ukraine and Israel) and cold wars (with China, Russia, and Iran) to worry about.
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The irony, as Druckenmiller pointed out, is that if the Fed does anything to help ease the burden on Treasury (by lowering rates, or stopping QT), it will at the same time be less effective in tamping down inflation, which also boosts the deficit via higher costs, not to mention is politically unpopular.
So for all those declaring victory on the government's response to Covid and the Fed's fight against inflation, it's worth noting that both battles are not yet over.
See you at 1 p.m!
Kelly
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