The Coming Clash Between Elevated U.S. Debt Levels And Higher Interest Rates – February 22, 2022



The upcoming unwinding of monetary accommodation by the Federal Reserve and other central banks will have widespread and significant impacts on the global growth outlook and financial markets. One source of angst that has provided support to the long end of the Treasury market is the perception that elevated debt levels combined with higher borrowing costs will quickly translate into weaker economic growth. To this end, a just-published report analysed the vulnerability of the U.S. economy to higher interest rates. The conclusion was that the U.S. economy can withstand a significant rise in interest rates if the rise is orderly.

Overall debt levels have indeed increased post-pandemic, primarily due to a surge in government borrowing. However, the public sector has not historically been interest rate sensitive, and there is little risk of financing strains over the next few years unless Congress triggers a debt-ceiling crisis. Importantly, the household sector can comfortably absorb higher interest rates after a decade of deleveraging and the current historically low debt-servicing ratio. And robust profits and cash flows provide a significant cushion for the corporate sector as interest rates rise.

In sum, the U.S. economy is healthier than many perceive and will not be jeopardized by an orderly rise in real interest rates well into positive territory. Financial market volatility, however, will be elevated as the monetary adjustment progresses.

 







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