In response to When Will Interest on US National Debt Exceed $1 Trillion some readers objected stating “things are different now”. I had to laugh at that.

Others stated that I ignored duration. I did, but I did post results at various interest rates, one of them optimistically assuming rates would stay at current levels.

For ease in discussion, here is the chart again, with my original “fed is in a box” claim. An analysis of “debt duration follows”.

Projected Interest at Various Rates

Hidden Agenda

The current blended rate of interest on the national debt is a mere 2.4% according to the CBO.

The “optimistic” projection of $668 billion assumes the rate will stay below 3.1% through 2020.

Shifting Goalposts

Really think the Fed is going to hike? They know they can’t, and the Fed is disingenuous as to why.

A year ago the Fed was discussing 6.5% as a trigger point.

In December, the Wall Street Journal noted the Fed’s Shifting Unemployment Guideposts

Now, in the wake of a massive collapse in the labor force in which unemployment rate just dropped to 6.7% it’s easy to understand why the goalposts shifted.

The Fed pretends its interest rate policy is about a dual mandate of jobs and GDP growth.

The above charts show the real reason for the shift: the Fed is in a box of its own making and it has no freaking idea how to get out of the box.

Duration Weighted Average

Reader “Paul” pointed me to the OMB Fiscal Year 2012 Q1 Report.

There are lots of interesting charts in the report, but especially note the chart on page 15, shown below (annotations in red are mine).

Duration is expected to rise from from about 67 months (5.58 years) to about 78 months (6.5 years).

Current Trends

According to Bloomberg, yields are rising sharply on the long end.

click on chart for sharper image

Yield on the 5-Year note is currently 1.59%. A year ago it was 0.78%. Yield on the 10-Year note is 2.83%. A year ago it was 1.87%.

Think the Fed can afford to let interest rates rise further?

I didn’t and still don’t.

Even though the average duration is now 5.5 years, The Fed Owns 40% Of All Treasuries Over 5 Years In Maturity.

According to Forbes (see above link), during 4 years of QE, QE1, QE2, and QE3, the Fed accumulated 36% of all Treasury securities between 5 years and 10 years in maturity plus 40% of those government bonds over 10 years in maturity, as well as 25% of all the mortgage backed securities not owned by Fannie Mae and Freddie Mac.

What’s the Fed going to do now? Accumulate all the notes and bonds? While buying less of them? The math doesn’t quite work does it?

Communication the Only “Tool” Left

The Fed hopes to stabilize rates via communication, hoping to convince everyone of three things

  1. The economy is strengthening
  2. Regardless of the strengthening economy, the Fed won’t hike rates
  3. Long-term rates should not rise

Three Problems

  1. If the economy is strengthening, interest rates should rise
  2. If the economy is headed into a recession or even weakening, then equity prices and corporate bonds are grossly overpriced
  3. The Fed is not really in control

Exit Strategy

So what is the Fed’s exit strategy?

The Fed really doesn’t have one, and that is the reason for all this meaningless communication from various Fed governors (frequently in contradiction with each other).

Mike “Mish” Shedlock