Now that the cognescenti have judged that goods/services price inflation has transitioned from transitory to something more persistent, the Fed has signaled that it is ready to start raising its main policy interest rate, the federal funds rate, at the mid March FOMC meeting. Moreover, the Fed has suggested that a March interest rate hike will be one of several this year. By how many basis points will the Fed raise the federal funds rate this year from its current level of 0.08%? No one knows, especially the Fed. The federal funds futures market is currently priced to suggest a cumulative 150 basis point rise in the federal funds rate over the next 12 months. But just as Fed policy is "data dependent", so is the federal funds futures market. However many basis points the Fed raises the federal funds rate over the next year, it will have a fiscal effect. That is, it will contribute to an increase in federal outlays in the form of higher net interest payments. Higher Treasury debt-servicing expenses imply higher future federal budget deficits, all else the same.
The blue bars in Chart 1 are the fiscal year values of Treasury net interest expenditures as a percent of total federal outlays. The blue bars in the shaded area from fiscal year 2022 through 2031 are baseline forecasts made by the Congressional Budget Office (CBO) in July 2021. CBO baseline projections of budgetary variables incorporate current laws pertaining to the federal budget and the CBO's estimate of economic variables that would have an impact on budgetary variables. Also plotted in Chart 1 are the actual and CBO-forecast fiscal year average values of interest rates for the three-month Treasury bill (the green line) and the 10-year Treasury note (the red line). In FY 2021, Treasury interest expense as a percent of total federal outlays was 4.8% -- the lowest percentage in the period starting FY 1965. Given that federal debt held by the public increased by $6.2 trillion in the two fiscal years ended 2021, this low ratio of Treasury debt service expense relative to total federal outlays is remarkable. Of course, extremely low interest rates on Treasury debt played a major role in reducing debt-servicing costs relative to total federal outlays. More on this in a moment.
Chart 1
Global