Bloomberg News

Dudley Sees Higher Interest Costs as Rates Climb Over Time

February 27, 2012

(Updates 10-year Treasury note yield in fifth paragraph.)

Feb. 24 (Bloomberg) -- Federal Reserve Bank of New York President William C. Dudley warned that interest costs on government debt will eventually increase as the central bank raises borrowing costs, and he said it is “essential” for the U.S. to start aiming for fiscal balance.

“We are in an unusual period in which net interest expense is temporarily depressed,” he said. “This will not last and the fiscal authorities need to factor this in when considering what needs to be done to put the federal budget deficit and the nation’s debt burden on a sustainable path.”

Dudley repeated last month’s statement by the Federal Open Market Committee that low rates of resource use and subdued inflation “are likely to warrant exceptionally low levels for the federal funds rate at least through late 2014.” He is a permanent voting member of the panel.

“These unusually low interest rates are the result of monetary policy actions taken by the FOMC,” Dudley said in remarks prepared for the U.S. Monetary Policy Forum hosted by the University of Chicago Booth School of Business. “The sole purpose of these actions has been to promote the dual mandate objectives of maximum employment and price stability in the wake of the financial crisis.”

The Fed is also putting downward pressure on long-term rates by extending the maturity of its portfolio. U.S. 10-year notes yielded 1.98 percent at 3:50 p.m. in New York, down from 3.44 percent a year ago. Two-year Treasury notes show that the government can borrow for that term at around 0.30 percent today.

Fed Remittances

The New York Fed president also noted that Treasury receipts have been boosted by the central bank’s remittances. The Fed’s balance sheet has grown to $2.935 trillion, up from $868 billion at the in June 2007, as it has purchased government debt to lower rates and support the expansion. Remittances rose to more than $75 billion per year over the last two years, after averaging $27 billion from 2005 to 2007, Dudley said.

“The low interest rates and enlarged balance sheet, which has generated these reduced borrowing costs, will not be sustained over time,” Dudley said. “The ancillary effects on the federal deficit from the Fed’s monetary policy actions are incidental and will prove temporary.”

As the Fed’s policy rates move up, and the balance sheet shrinks, the Treasury’s net interest burden will rise “sharply,” Dudley said.

--Editors: Christopher Wellisz, Kevin Costelloe

To contact the reporters on this story: Craig Torres in Washington at ctorres3@bloomberg.net; Caroline Salas Gage in New York at csalas1@bloomberg.net

To contact the editor responsible for this story: Christopher Wellisz at cwellisz@bloomberg.net


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