Conclusion: Analyzing the latest quarterly presentation of the Treasury Borrowing Advisory Committee leads to some pretty negative takeaways as it relates to the fiscal health of the U.S.
Position: Short the U.S. dollar (UUP); Short 1-3 year U.S. Treasuries (SHY)
Below is a collection of select charts we pulled from the Department of the Treasury’s latest quarterly presentation to the Treasury Borrowing Advisory Committee. Needless to say, all is not well in our Hedgeyes, which is evident in the analysis below. We continue to remain short the short end of the yield curve and the U.S. dollar to express our bearish conviction regarding the U.S. government’s fiscal health and the negative long term economic outlook domestically.
After having tax revenues trending well below the historical recovery average since the end of the recession, we’ve finally eclipsed the average four quarters into the recovery. Unfortunately, that’s comes just as the Bush tax cuts may be extended while employment is deteriorating and both consumer spending and housing appear to exhibit significant downside over the next 3-4 quarters.
Much of the growth in tax revenue have been driven by corporate tax receipts, which look to slow absent an effective tax hike in the upcoming period of slow growth and depressed top line growth. Many companies have been pulling margins levers to drive earnings growth in recent quarters so a tax hike could be disastrous for earnings going forward, as these companies don’t have much left to cut.
If the federal government eats the marginal loss in revenues, they will need to borrow more to fund a larger deficit on the margin. Based on the deficit projections from our Hedgeye models, their estimates for borrowing (i.e. Piling Debt Upon Debt) over the next two years are far too low.
With yields on the long end of the curve near historic lows, the average maturity of U.S. Treasury debt outstanding has continued to increase as the Treasury issues more long-dated paper. Currently, the average maturity is right at the 30-year average of 58 months, or 16 months above the 30-year minimum and 13 months below the 30-year maximum. Should this up-trend continue, U.S. Treasury holders in aggregate will be increasingly subject to further duration risk – which is noteworthy given the fiscal health of the country (see: PIIGS 2010).
The percentage of debt maturing in the near-term is at historic lows on a 20-year basis. Even still, roughly 31% of treasuries ($4.1 trillion) need to be refinanced in the next 12 months. Adding that with a consensus minimum of $950 billion in financing needs in FY11 leaves us with 38.2% of treasury debt needing to be financed in the next 16 months. Accounting for Hedgeye’s worst case scenario of $1.93 trillion in financing needs for FY11 takes the magic number up to 45.6%. This occurs at a time when it will likely become more difficult for the United States to roll over short term debt due to burgeoning fiscal issues.
A chart that really jumped out to us was their interest expense projections. Under baseline OMB scenarios (which we have shown in our previous work to assume above-trend growth and below-trend expenditures), the federal budget’s interest expense will jump to nearly 4% of GDP in just ten years – a near 275bps increase from today’s ratio of ~1.25%! This is not surprising given the upward direction of the average maturity of public debt outstanding. A domestic interest expense near 4% of GDP is well above the historic average for the previous 60 years and this rise will naturally present significant trouble for the fiscal health of the United States over the next decade – especially considering the current direction of entitlement and healthcare spending. Either taxes will have to ramp up significantly in the next 5-10 years or the U.S. will continue to have to Pile MORE Debt Upon Debt to fund its deficits. Either result is negative for future economic growth domestically.
The next chart highlights a pretty interesting conundrum the U.S. federal government is in regarding the direction of interest expenses. When compared to many of its Western European and Japanese counterparts, we see the weighted average maturity of U.S. Treasury debt outstanding is below the group average. This means that the Department of the Treasury has room to take advantage of depressed yields at the long end of the curve and issue more long-dated securities, further increasing the interest rate burden on the federal government P&L. Should the U.S. remain a group laggard and/or reduce its average maturity profile, it will leave itself more exposed to market sentiment and a potential crisis of confidence in U.S. Treasury debt. China has been selling U.S. Treasuries and should any other major holder (i.e. Japan, U.S. commercial banks, U.S. pension and hedge funds, etc.) follow suit, the U.S. government could potentially face a substantial refinancing crisis if rates on the short end of the curve back up meaningfully.
The last chart we want to highlight shows U.S. Treasury issuance will continue to dominate the debt supply landscape over the next couple of years, further crowding out private sector investment. Not much else to say here other than the fact that we are likely to face below trend GDP growth from a lack of private investment as long as the grey bar continues to dominate the chart below.
All told, we continue to remain short the short end of the yield curve and the U.S. dollar to express our bearish conviction regarding the U.S. government’s fiscal health and the negative long term economic outlook. The federal government’s aggressive baseline projections highlight some pretty negative trends and the more conservative Hedgeye models suggest even more downside as it relates to the intermediate-to-long-term fiscal heath of the U.S.