As Europe Sovereign Debt Fears Grow, US Will Have An Easier Time Funding The Deficit

The risk, at least in the minds of bond and currency traders, is that the financial chaos Europe is sliding into has been getting worse each day despite the bailout of Greece. The Greek population is rebelling against austerity conditions. The country’s air traffic controllers have walked off the job which could eventually hurt the nation’s lucrative tourism business.

Fears about Spain and Portugal are also growing. The cost to insure the debt of Portugal jumped by 82 basis points to 366 basis points, which mean it costs $366,000 per year for five years to insure $10 million in debt.

The cost of insuring Spanish debt is not much better. If either Spain or Portugal move toward default, the price that these countries will have to pay to finance their deficits in the global capital markets could become unsustainable if they can sell the paper at all. That creates a vicious cycle where deficit coverage is joined by the cost of interest rate payments as extremely high levels.

The Treasury said it will have to raise $340 billion this quarter and $716 billion over the two quarters that end on September 30. The US government is forecast to need nearly as much next year, and if unemployment lingers Congress will almost certainly have to spend tens of billions of dollar for payments to the jobless.

The Treasury’s need for new capital raise the specter that America would have to pay higher and higher rates to bring in new money. The CBO projected that the US will be paying $700 billion a year in debt service at the end of the decade. If US borrowing costs go higher, the figure could be worse.

But, US borrowing costs are going down. The yield on 10-year Treasuries has dropped to 3.59%. Five days ago that number was 3.82%. On April 5, the rate was 3.99%.

The US could certainly be hurt by a financial catastrophe in Europe. American exports could be affected. Some US banks may have exposure to sovereign paper from the region. For the time being, however, the world views American Treasuries as a safe place to put capital, and that could keep US borrowing costs down  just when the country is involved in its most aggressive fund-raising ever.

Douglas A. McIntyre