There Are No Winners In An Inflation Fight

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To investors,

The US government is already paying more than $1 trillion in annual interest payments on the national debt. That is a mind-boggling number that is set to get much worse in the coming year if something doesn’t change quickly.

The debt servicing cost of national debt around the world has been steadily rising in recent years. Smaller, low-income countries are suffering more than large countries, but no country has been immune to the problem.

Countries had to take on significantly more debt to deal with the pandemic and various secondary issues. That debt came at a time of low-interest rates, but now that interest rates are rising, and many countries have not stopped borrowing, the servicing costs will continue to grow rapidly.

The United States is a good example of the trouble ahead. More than 30% of all US federal debt is set to roll over in 2024, which is over $7.5 trillion.

This is problematic because the refinancing cost of this debt is the worst it has been in more than two decades. The average interest rate on each global bond that rolls over will increase by more than 100 basis points.

Thankfully, there was relief on the way at the start of this year. The market believed the Federal Reserve would cut interest rates and the refinancing costs of some of the debt would drop simultaneously.

The market believes that story less today than it did just 7 weeks ago.

Jim Bianco explains with this chart and overview:

“Here are the probabilities of the first Fed cut over the next four FOMC meetings.

• The next FOMC meeting is on March 20 (brown). The market is pricing just a 3% probability of a cut. This was nearly 90% at the beginning of the year.

• The May 1 FOMC (green) is down to 24%. Being well below 50%, it is unlikely this meeting will see a cut. Right before the January Payroll report (massive beat of 353k), the pricing had a 95% probability of a cut in May.

• The June 12 FOMC (blue) has a 65.54% probability that the Fed will cut at this meeting, so a cut is still priced in (above 50%). However, this was 100% the day before the beat in the January payroll report and 92% the day before the beat (more than expected) in January CPI.

• The July 31 FOMC meeting (red) has an 85% probability of a cut. But note this was 98% the day before the January CPI report (February 12).

In other words, all the probabilities are in a downtrend. So, while March and May are priced out, check back after February payrolls and CPI to see where all these probabilities are. If payrolls and CPI are again strong (above consensus), I would look for June and July cuts to get priced out.” - Jim Bianco

This is an important point from Bianco because the relief that was on the way seems to be quietly walking out the back door of the party. The US will continue to have higher interest payments on the debt until the Fed can cut rates. The Fed can’t cut rates until they are sure that inflation won’t come roaring back.

According to Molly Smith and Craig Stirling at Bloomberg:

“Underlying US inflation probably rose in January by the most in a year, as tracked by the Federal Reserve’s preferred metric, highlighting the long and bumpy path to taming price pressures.

The core personal consumption expenditures price index, which excludes food and energy costs, is seen rising 0.4% from a month earlier. That would mark the second straight monthly acceleration in a gauge that’s largely been receding over the past two years.”

The Fed is officially in a lose-lose situation. Keep interest rates high and you will probably push the US economy into a recession. Cut interest rates and risk inflation coming back to ruin your legacy.

There are no winners in an inflation fight.

And while this is going on, the American people will continue to see more than 40% of all personal income tax dollars spent on servicing the debt. Rather than having those dollars devoted to better education, defense, infrastructure, and various other services, the money evaporates into thin air as interest payments.

Not exactly the news we want as the US heads into tax season.

Hope you all have a great day. I’ll talk to everyone tomorrow.

-Anthony Pompliano

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Santiago Pilego is the Director who leads the venture side of a company called New Founding.

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