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Why lower deficit can’t save the bond market

Talking Numbers

The federal budget deficit dropped below $700 billion this past year. What's next for rates?

Good news for budget hawks: The federal budget deficit is finally below $1 trillion for the first time in half a decade. In fact, it's clocked in at under $700 billion. That can have some interesting consequences, particularly with what the Federal Reserve Bank does next.

According to the Treasury Department, the US deficit was about $680 billion. That's about half of what it was in 2009 but still more than 2008's $455 billion deficit, which was the record before the financial crisis. The government took in $2.77 trillion in revenues, which was about 13% higher than the previous year. Treasury says the increase is four-fifths due to higher tax receipts. Spending is also down 2.4% to $3.45 trillion, in part because of the "sequester" that began in March.

(Watch: Deficit hits 5-year low)

In 2008, the total government debt held by the US public was $5.8 trillion, according to the Congressional Budget Office. Over the last five years, the government spent an additional $5.8 trillion more than it took in. Add to that interest and $4.9 trillion in intragovernmental holdings (Social Security and the like) and you get a total debt of $17.1 trillion. To put it in perspective, over the last twelve months, the entire US Gross Domestic Product was $15.7 trillion.

Interest payment on all of that debt for the fiscal year was $415.6 billion, or about 61% of the US deficit. Basically, the US is borrowing money to pay its debt and then some.

Factoring in how money changes hands (its velocity) in the economy, and interest payment on government debt has a cost, according to Andrew Busch, Editor and Publisher of The Busch Report. With debt now more than the GDP, "this translates to a loss of around 1% of GDP per year to service the interest on the debt," notes Busch. "As far as bonds go, this is something that's helpful but they've got a long way to go. It's the overall problem with the deficits and the debt in the United States – especially with entitlements – that's the key to the bonds future."

(Watch: Why Obamacare could raise your premiums at work)

On the technicals, Steven Pytlar, Chief Equity Strategist at Prime Executions, notes that US Treasury 10-year bonds have been in a downtrend for well over a month and are yields are now testing the 2.47% support level. "What generally happens on a technical basis when you come into the downside target at first support is you start to chop sideways and the market waits for the next signal," says Pytlar. "That's what we're doing right now."

What can we expect when we break through these key levels? To see more analyses by Busch and Pytlar on what's next for US interest rates, watch the video above.

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