The last decade saw a significant rise in Government debt levels.

This hasn’t really been a problem until now, for two reasons:

Firstly, Interest rates were lower than historically, so old debt was rolling over with higher interest rates and being refinanced cheaper with lower. Even with total debt levels increasing the total servicing cost was contained. 

In the US, the debt cost was circa $300 Billion last year.

Secondly, the interest rates being paid on Government debt were below the inflation rate. This meant that debt value was actually decreasing year on year. Inflation was eating away at the debt owed. Not by being high, but low in itself and higher than interest rates.

This is why risk assets did well. Cash was trash and interest rates were no protection against inflation. So people bought equities, real estate etc which gave above inflation returns.

Epic Historic Financial Tightening

If you combine over the last few months the effects of higher rates, higher dollar and quantitative tightening, then we are seeing the largest, fastest tightening of financial conditions ever. This is no hyperbole, EVER in recorded history.

It’s causing huge issues for markets both because of the amounts being done but just as importantly the speed it’s being implemented.

So why are the Fed being so apparently reckless?

The answers are the stuff of many leather bound books but consider this.

If the interest rate on US Government debt is 3% higher than last year that’s a cost of over $1 Trillion a year. That’s higher than their total social security budget.

So the Fed who plainly know this are looking at inflation and saying,

“We have no choice. Even if we break stuff we’ve got to get it down super-fast before it imbeds, because if we don’t the debt servicing is unsustainable”.

The Good News

When they stabilise the economy to the point where interest rates can be equal to or lower than the inflation rate again, then we will return to the playbook of risk assets doing well.

They plainly mean business and given the figures above we can understand why.

Note: This is written in a personal capacity and reflects the view of the author. It does not necessarily reflect the view of LWM Consultants. The post has been checked and approved to ensure that it is both accurate and not misleading. However, this is a blog, and the reader should accept that by its very nature many of the points are subjective and opinions of the author. Individuals wishing to buy any product or service as a result of this blog must seek advice or carry out their own research before making any decision, the author will not be held liable for decisions made as a result of this blog (particularly where no advice has been sought). Investors should also note that past performance is not a guide to future performance and investments can fall as well as rise.