U.S. still spends nearly $1 trillion a year on debt interest despite rate cut

The U.S. government is still bleeding nearly $1 trillion every year just to cover interest payments on its debt, and that long-awaited rate cut from Jerome Powell isn’t going to change that.

Roughly 80% of federal debt is made up of notes and bonds with terms locked in for anywhere from two to thirty years. Those rates were locked when the securities were first issued, and no amount of trimming short-term rates will unwind those old contracts.

New lower-rate borrowing can only happen when those older ones mature, which takes years. Jessica Riedl, senior fellow at the Manhattan Institute, said, “You’re not going to drastically change budget deficits that are approaching $2 trillion. It’s too small of a rate change on too small a share of our total debt.”

Long-term bonds still crush federal finances

Washington’s main interest relief comes through short-term Treasury bills that are often issued and have durations as short as four weeks. Those bills do respond to Fed rate changes quickly.

But that’s a small part of the overall federal debt. The rest is stuck under older, higher-rate contracts that don’t budge with short-term cuts. And even if long-term yields dip, it takes time for cheaper replacements to cycle in.

Investors also don’t just look at what Powell does with the Fed’s short-term rate. They factor in long-run inflation risks, fears over Fed independence, and the overall fiscal path of the U.S. government.

Jared Bernstein, head of the White House Council of Economic Advisers, said, “Investors still seem to be seeking a term premium when they lend to us.” That means they want more interest in return for locking in their money long-term. This keeps the yield curve steep and the government’s long-term borrowing costs high.

The U.S. now spends more on interest than it does on defense. One dollar out of every seven in the federal budget goes toward interest. Fifty years ago, interest payments were about half the size of military spending. Now, they’ve passed it.

The mountain of debt got this high because of a mix of tax cuts, rising costs from entitlement programs, pandemic-related spending, and leftover damage from the 2008 financial crisis. Publicly held debt is now approaching 100% of GDP, nearing the post-World War II record of 106%.

A small move in interest rates, just 0.1 percentage point, would cost the country $351 billion over ten years, based on estimates from the Congressional Budget Office. That’s more than what the new tax law saves by ending credits for electric vehicles and solar panels.

Trump pushes for deeper cuts, but math says otherwise

President Donald Trump has kept hammering Powell, accusing him of moving too slowly on rate cuts. “Because the rate’s high, we have to pay more for debt,” Trump said in June. He argued the U.S. could save $900 billion annually if the Fed lowered rates by three full percentage points.

That would require a cut twelve times bigger than what Powell just delivered. And even then, the savings would depend on long-term borrowing rates dropping just as fast, which almost never happens.

The yield on the 10-year Treasury note has mostly stayed between 4.0% and 4.7% this year. It briefly dipped when the Fed announced more cuts were coming, but then it bounced back over 4.1%. That shows investors still expect inflation, and they’re not convinced Powell’s moves will be enough.

One way the government could lower its interest costs is by tweaking the types of debt it sells. If short-term rates are lower, the Treasury might issue more short-term bills. That’s what officials are hinting at now. They also believe crypto growth, especially in stablecoins, could increase demand for those short-term Treasury bills.

But not everyone agrees with that strategy. Stephen Miran, Trump’s chief economist and pick for the Fed’s Board of Governors, argued last year that the Biden team leaned too hard on short-term borrowing.

Treasury Secretary Scott Bessent backed that view. Issuing more short-term debt helps when rates are low, but it also leaves the government exposed if those rates rise quickly.

Another option is to issue more long-term debt when those rates are low, something that could have been done during the pandemic. Back then, Treasurys were seen as ultra-safe, and interest rates were way down.

Bank of America data shows the average interest on Treasury notes and bonds dropped from over 2.5% to as low as 1.7% in early 2022. But Washington didn’t lock in those deals. Now, that average has climbed back over 3% as of March and keeps going up.

“There’s this line of thinking that we should have refinanced the debt at lower interest rates when we had the chance,” said Gennadiy Goldberg, head of U.S. rate strategy at TD Securities. “We did.” But it wasn’t enough to move the needle.

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