Global Macro Monitor

Summary

• Largely ignored by the markets,  Social Security moved into structural deficit this year
• Social Security has been running primary deficits since the GFC; that is financing itself by the interest earned on Treasury securities
• The government will no longer be able to borrow from the Social Security Trust Fund ( Old-Age Survivors Insurance (OASI) Trust Fund) to fund its on-budget deficits
• The Social Security Trust Fund financed more than half the U.S. budget deficit during the mid-2000’s
• The result will be more market supply of Treasury securities and upward pressure on interest rates
• This post is an excerpt of our Sep 23rd post, The Gathering Storm In The Treasury Market 2.0

We suspect our Sep 23rd beast of a post,  The Gathering Storm In The Treasury Market 2.0,  was TLDR – Too Long, Didn’t Read.  One famous blogger said of it, “This post is so big, you can see it from space.”   We feel it was an important read for any market watcher as the 10-year T-Note yield is the most important price in the world.

In that post we which laid out why several factors which have kept U.S. long-term interest rates low and repressed term premium suppressed are fading,

Impatience and ADD equals missed opportunities,  as we wrote in the summary bullet points,

• The yield curve is flat for technical reasons, and we believe term premia will increase
• We expect a measured move in the 10-year Treasury yield to 4.25 to 4.40 percent, much sooner than the Street anticipates  – GMM, Sept 23rd

That was just before the 10-year yield broke out.

We are going to slice and dice the that post for an easier read for those of us use to 140 280 characters.

We named four significant factors that were changing and set to move long-term interest rates higher and increase the term premium.   This post extracts and focuses on the little noticed fact that Social Security has moved from surplus to deficit this year and the impact it will have on the Treasury market.

More than 70 million baby boomers are in the process of retiring and Social Security and Medicare are projected to run an  $82 trillion cash deficit over the next 30 years

Posted on September 24rd

Social Security Now In Deficit 

Another significant structural change in 2018 is that Social Security (SS) has moved into structural deficit.  In fact, SS began running a primary deficit (noninterest income less payouts) just after the GFC.

Source:  Social Security Administration 

Our chart below shows the U.S. government ’s off-budget balance, which only includes social security and postal service, the federal entities protected from the normal budget process, and excluded from budget caps, sequestration, and pay-as-you-go requirements.  The postal service is a tiny fraction of the balance.

The important takeaway is that the social security surpluses were used to build asset or reserves in their two trust funds:

1) Old-Age Survivors Insurance (OASI) Trust Fund, which pays retirement and survivors benefits, and 2) Disability Insurance (DI) Trust Fund, which pays disability benefits.

If one looks past the cash flow transactions to the impact on actual payments to and from the public, it becomes clear that an increase in trust fund reserves will be associated with a decrease in publicly held Treasury securities. That decrease in turn reduces the Treasury’s current cash needs for interest payments to the public and its need to borrow to make those cash payments.
– Social Security Administration

The large surpluses before the GFC (see above charts) provided a sizeable portion of the financing of the government’s on-budget deficit.   For example, the off-budget surpluses from 2002-2008 averaged $173.5 billion per year, which financed, on average, 40 percent of the on-budget deficits.

In other words, social security provided the U.S. government with a significant free-ride of deficit financing, and took substantial pressure off the markets, keeping interest rates low.

The next chart illustrates how the Treasury is becoming increasingly dependent on market financing as the social security surpluses faded and are now in deficit.  Marketable debt currently makes up 71 percent of the over $21 trillion total public debt versus  49 percent in 2007.

The upshot?  More relative issuance of Treasuries into the market and pressure on interest rates to increase and to crowd out other borrowers.