By Haddon Libby
Last week, Federal Reserve Chairman Jay Powell spoke with the press regarding the November 1st decision by the Federal Open Markets Committed to leave the Fed Funds rate in the 5.25% to 5.5% range. During the press conference, he inferred that the Fed was done with interest rates increases. While Powell left the door open for additional rate increases if inflation were to reignite, he stated that they wanted to let an 8% mortgage rate work its way through the economy.
The stock market interpreted his remarks as a sign that the long-anticipated recession is here, or will be here shortly and rallied. The anticipated ‘Christmas Rally’ may have arrived early as well.
This economic slowdown is different than most in that Gross Domestic Product (GDP) grew by 4.9%. to just under $21 trillion while unemployment stayed low. People are working harder to earn more to combat the impact of inflation and dwindling cash reserves. Government infrastructure projects also had a stimulative impact.
The good news of all of this is that we may not slip into a recession after all. Should prices begin to decline as the Fed anticipates, some of the pressure on American wallets may alleviate.
There are dark economic clouds on the horizon. Federal debt outstanding is currently $33 trillion or 1.6% GDP. This equates to $100,000 per American.
In the United States, the Fed alone held $890 billion of this debt on their balance sheet just before The Great Recession of 2008. The Fed balance sheet peaked at $9 trillion in May 2022 and is currently $7.9 trillion. The Fed have stated a near-term objective of reducing its balance sheet to $6 trillion. This level of Treasury issuance has resulted in a 6-month Treasury yield of 5.5% with a 30-year Treasury is just over 4%. As this debt is state-tax exempt, these rates present income hungry investors with a strong alternative to equities, many corporate bonds and bank CDs.
Fifteen years ago, federal debt totaled $9 trillion. By the end of the Obama administration, government debt had more than doubled to $19.5 trillion with the Fed holding $4.5 trillion.
Just before the COVID lockdowns in 2019, government debt was $22.7 trillion. By the end of the Trump Administration (as vaccines were deployed), federal debt had grown to $28 trillion. By the time of the Presidential elections next year, the Biden Administration will have overseen an increase in government debt to $35 trillion.
Over the last 15 years, government debt has grown by $26 trillion.
Last week, billionaire investor Stanley Druckenmiller spoke out against the ‘reckless spending’ of Washington DC. Druckenmiller pointed out that federal debt as a percentage of Gross Domestic Product had climbed from 20% prior to COVID to 25% today.
Where would Druckenmiller suggest cuts to federal spending? Entitlements. He does not want to cut entitlements to current retirees but future retirees. His financial analysis shows that current retirees have or will receive more than 100% of the money contributed to the social security system. His fear is that younger Americans who are just entering the workforce may only receive 5-10% of those received by current seniors.
Mary Johnson of The Senior Citizens League states that half of all retirees survive on Social Security and Medicare alone. With the retirement of Baby Boomers and increased lifespans, the Social Security fund is projected to run out of money by 2033. At present, the Social Security Trust holds $2.8 trillion in federal debt.
If these financial concerns are not enough, Druckenmiller stated that if rates stay at current levels for a few years, interest costs on government debt will increase by $2 trillion and consume nearly half of all government receipts. Instead of doing what many Americans did in locking into lower cost mortgages, the government did not issue long-term debt but shorter-term debt…at a time when rates were at the lowest levels in history.
Given the dysfunctional circus known as Washington DC, few believe a fix will come before some painful crisis.
Haddon Libby is the Founder and Chief Investment Officer of Winslow Drake Investment Management, a RIA firm. For more information on our services, please visit www.WinslowDrake.com