Jerome Powell said today that the Federal Reserve has no choice but to face the mounting U.S. debt balance. That negative balance is now $21.9 trillion.

The annual U.S. deficit has reached sustained highs of over $1 trillion.

Speaking at The Economic Club of Washington, D.C today Powell said:

“I’m very worried about it.”

Referring to the long-term implications which can be easily ignored when focusing on shorter-term policies Powell said:

“The long-run fiscal, non-sustainability of the U.S. federal government isn’t really something that plays into the medium-term that is relevant for our policy decisions.”

Adding:

“It’s a long-run issue that we definitely need to face, and ultimately, will have no choice but to face.”

Federal Reserve Policy May Have Exacerbated U.S. Debt

The Federal Reserve has been pursuing a policy of quantitative tightening. This to counter the quantitative easing put in place in response to the global economic crisis. It has been reducing the amount of U.S Treasury Bonds it purchased by allowing these holdings to expire.

This means the Federal Reserve is earning less interest on its holdings. Interest that usually contributes positively to the treasury balance. Through increased interest rates, government debt gets a higher cost of interest, adding to the debt balance.

That said, the Federal Reserve’s impact on the accruing U.S. debt is minor compared to the biggest culprit – government spending.

A Suicide Mission or a Debt Bomb?

Wall Street legend Jeffrey Gundlach warned in December that the federal reserve appeared to be on a “suicide mission” to be raising interest rates at the same time as U.S. debt is increasing. An expanding deficit can often be a signal for the federal reserve to lower interest rates, instead of potentially compounding a problem.

Banker and author Satyajit Das questioned in April 2018 if in fact the process of normalization after years of quantitative easing to counter recession could “set off a debt bomb.” Das wrote:

“A decade of unprecedently low global rates and abundant liquidity appears to have encouraged a spree of public and private debt accumulation.”

Adding:

“Higher interest rates will exacerbate the risk of financial distress for highly indebted corporate and sovereign borrowers.”

The fact that Powell is concerned about debt is not bad news for the markets. It actually makes further interest rate hikes less likely as Powell will be concerned about further compounding the U.S. debt balance. It could even mean the Federal Reserve considers an interest rate reduction.

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