My “exploding national debt” trade has been one of my most profitable and consistent positions of the past eight months.
Sellers of the iShares 20 Year Plus Treasury Bond Fund ETF (TLT) and buyers of the ProShares Ultra Short 20 Year Plus Treasury ETF (TBT) have seen riches rain down upon them.
With ten year Treasury bond yields grinding up from 2.03% to 2.95% during this period, what else would you expect?
It looks like things are going to get a whole lot better. For not only is the federal government now on an endless borrowing binge, so is the rest of the country.
We are, in fact, becoming the United States of Debt.
That Washington is taking the lead in this frenzy of borrowing is undeniable. Since the new administration came into power a year ago, the budget deficit has nearly doubled from $450 billion to $700 billion.
The package of unfunded tax cuts passed in December look to take it to $1.2 trillion by the end of 2018.
Another $300 billion in deficit spending was piled on in February just to keep the government open for a few more weeks.
Add it all up and the United States government is on track to take the National Debt from $20.5 trillion to $30 trillion within a decade.
The National Debt exceeded US GDP in 2016, taking the debt to GDP ratio to the highest point since WWII.
Just retired Fed governor Janet Yellen recently confided to me that, “It’s the kind of thing that should keep you awake at night.”
It gets worse.
According to the Federal Reserve Bank of New York, total personal debt topped $13 trillion by the end of 2017. An overwhelming share of personal consumption is now funded by credit card borrowing.
Some 33% of Americans now have debts in some form of collection, and that figure reaches an astonishing 50% in many southern states (see map below). Call it the Confederacy of Debt.
Corporations have also been visiting the money trough with increasing frequency, taking their debt to $6.1 trillion, up by 39% in five years, and by 85% in a decade.
The debt to capital ratio of the top 1,000 companies has ballooned from 35% to 54% and is now the highest in 20 years.
Another foreboding indicator is that corporate debt is rising faster than sales, with debt rising by a breakneck 8.5% annualized compared to 4.6% for sales over the past decade.
Automobile debt now tops $1 trillion and with lax standards has become the new subprime market.
And remember that other 800-pound gorilla in the room? Student debt now exceeds $1.4 trillion and is rising, as is the default rate. Provisions in the new tax bill eliminate the deductibility of the interest on student debt, making lives increasingly miserable for young borrowers.
Of course, you can blame the low interest rates that have prevailed for the past decade. Who doesn’t want to borrow when the inflation adjusted long-term cost of money is FREE?
That explains why Apple (AAPL), with $270 billion in cash reserves held overseas, has been borrowing via ultra-low coupon 30-year bond issues, even though it doesn’t need the money. Many other major corporations have done the same.
And while everything looks fine on paper now, what happens if interest rates rise?
The Feds will be in dire straights very quickly. Raise short term rates to the 6% seen at the peak of the last cycle, and the nation’s debt service rockets from 4% to over 10%. That’s when the sushi really hits the fan.
You can expect the same kind of vicious math to strike across the entire spectrum of heavily leveraged borrowers going forward, including you and me.
Rising rates are increasingly shutting first time buying Millennials out of the housing market, as the shocking 3.2% decline in the January Existing Home Sales amply demonstrated.
Remember, all this new bond issuance is occurring in the face of rapidly flagging demand now that the Federal Reserve is out of the quantitative easing business. Their current plan is to suck $4 trillion of liquidity out of the system over the next decade.
We are also witnessing the withdrawal of the Chinese as major Treasury bond buyers, who along with other sovereign buyers historically took as much as 50% of every issue.
Don’t expect them back until the dollar starts to appreciate again, unlikely in the face of ballooning federal deficits.
Rising supply against fewer buyers sounds like a recipe for much higher interest rates to me.
Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.