Latest / The Federal Reserve Podcast with Fexingo: Interest Rates, FOMC Meetings, and Monetary Policy / The $40 Trillion Debt Ceiling Dilemma
Transcript
- Lucas: So the U.S. national debt just crossed forty trillion dollars. That's more than double what it was a decade ago. And the timing, right as the Fed is trying to steer inflation back to target, feels anything but coincidental. Luna: Forty trillion is such a big number it's hard to wrap your head around. But what does that mean for the Fed specifically? They don't set fiscal policy. Lucas: Right, they don't. But the scale of the debt changes the backdrop for every decision they make. Right now, the effective fed funds rate is sitting at three point six three percent, and the ten-year Treasury is yielding four point seven percent. That means the cost of servicing that forty trillion is enormous. The Treasury is paying out hundreds of billions in interest, and that eats into the government's ability to do anything else. Luna: And that's where the political pressure comes in. Donald Trump has been tweeting, well, he's been saying publicly that the Fed should be cutting rates because the country should be paying much less on its debt. Lucas: Exactly. And that's a classic tension. The Fed's job is price stability and maximum employment, not keeping the government's borrowing costs low. But when the debt gets this big, politicians start looking at the Fed's interest rate decisions through a very different lens. Every basis point they don't cut is, in the eyes of the White House, money wasted on interest. Luna: But the Fed has to stay focused on inflation. Core CPI is still running at three point three percent year-over-year. That's above their two percent target. So they can't just cut rates because the debt is big. Lucas: No, they can't. And that's the core dilemma. The Fed's independence is what gives its inflation fighting credibility. If markets start to believe the Fed is kowtowing to political pressure to keep rates low, then inflation expectations could unanchor. You'd see that in the ten-year breakeven, which right now is two point three percent, roughly in line with target. But that stability is fragile. Luna: So what's the Fed's play? Do they just ignore the political noise and keep rates where they are? Lucas: They have to. I mean, look, the Fed has been through this before. In the late seventies and early eighties, Paul Volcker hiked rates to double digits despite intense political pressure. It worked, but it also caused a recession. The difference now is the debt load. Back then, total public debt as a share of GDP was around thirty percent. Today it's over one hundred twenty percent. So the stakes are higher. Luna: That's a huge difference. And it makes the Fed's job trickier because every rate hike increases the government's interest bill, which in turn widens the deficit, which in turn means more Treasury issuance, which could push long-term rates higher anyway. It's like a feedback loop. Lucas: Precisely. And that's why the Treasury is beginning to do these buyback operations. Scott Bessent, the Treasury Secretary, said today that the next buyback could be over four billion dollars. It's a way to manage the debt, to smooth out the maturity curve. But it also shows how intertwined fiscal and monetary policy have become. Luna: Buybacks are interesting. They're not something the Treasury has done in a long time. So is that a signal that they're worried about market functioning? Lucas: Partly. But also, they're just trying to keep the market for Treasuries liquid. When you have this much supply coming, you want to make sure there's enough demand. The Fed used to be a big buyer, but now they're not. So the Treasury has to find other ways to support the market. That's where buybacks come in. Luna: So the Fed is out of the game, but the Treasury is stepping in. That's a new era, isn't it? Lucas: It is. And it's a delicate dance. The Fed wants to maintain its independence, but it also has to be mindful of the fiscal situation. They're not going to say it out loud, but the level of debt is a constraint on how high they can push rates. If they hike too much, the government's interest costs become unsustainable, and that could cause its own crisis. Luna: That's a scary thought. So are we looking at a scenario where the Fed is essentially trapped? They can't cut because inflation is sticky, and they can't hike because of the debt? Lucas: It's a narrow path, for sure. But they've been here before, sort of. In the mid-nineties, Greenspan faced a similar, though less extreme, version. He managed to thread the needle by being very transparent about his thinking. And we're seeing that now with forward guidance. Powell has said repeatedly that they're data-dependent. That's his way of saying, don't expect us to react to politics. Luna: And the data they're watching, like core PCE, is still above target. So that keeps them on hold. Lucas: Right. Core PCE is running at two point eight percent, down from last month, but still above two. And core CPI is three point three. So the trend is good, but it's not there yet. The Fed wants to see sustained evidence that inflation is coming down before they ease. They don't want to declare victory too early. Luna: It's like they're the adult in the room, but everyone else is shouting at them from the cheap seats. Lucas: That's a good way to put it. And that's exactly why we do this show. We try to cut through the noise and explain what's actually happening. That's our thing. We're not taking ads, we're not selling anything, we just want to give you a clear picture of the economy. If listening to us has made something click for you, we'd appreciate it if you considered supporting us. You can do that at buy me a coffee dot com slash fexingo. It's a simple way to keep this show ad-free and running. Luna: Yeah, it really helps us keep the lights on. And we don't get bogged down by sponsors trying to influence our take. That's worth something. Lucas: It is. So back to the debt. Bessent also said the budget deficit has probably peaked. That's a bold claim, especially with the debt at forty trillion. But if he's right, that could take some pressure off the Fed. A smaller deficit means less Treasury issuance, which means less upward pressure on long-term rates. That would give the Fed more room to maneuver. Luna: But that's a big if. Deficits have a way of coming back. And with spending on Social Security and Medicare set to rise, I'm not sure the peak is here. Lucas: Historically, you're right. And that's the kind of uncertainty the Fed has to live with. They can't control fiscal policy, they can only react to it. That's why they're so focused on inflation expectations. If people believe the Fed will do whatever it takes to keep inflation in check, then they don't have to actually do as much. That credibility is their most valuable asset. Luna: And that's why a tweet from the president can be so dangerous to the Fed's mission. Even if they ignore it, the market might read something into it. Lucas: Exactly. That's why they have to be so careful with their communication. Every word Powell says is parsed. That's the price of transparency. But it also means they can use their words to guide the market without having to move rates. That's a tool in itself. Luna: So, in a way, the Fed is more powerful than ever, but also more constrained. It's a paradox. Lucas: That's the reality of central banking in the twenty-first century. They hold the levers, but the room they're in is shrinking. And with the debt crossing forty trillion, that room is going to get even smaller. It's a challenge they're going to have to navigate for the next decade, at least. Luna: Well, it's a good thing we're here to keep track of it. Thanks for having this conversation, Lucas. Lucas: Always. And thanks to you for listening. We'll be back tomorrow with more of what's shaping the economy.