The long run concern with US Debt
On Wednesday morning, after an all-night session, the lower chamber of U.S. Congress passed the administration’s tax bill by a single vote. The Senate will take it up next. While the Republicans hold a majority, the budget remains a subject of intense debate. Without getting into the weeds, we have heard that it is expected to add between $3.3-$5.0 trillion to the national debt over the next 10 years. The increase is due to projected decline in tax receipts, resulting from the continuation of 2017 tax cuts without a corresponding reduction in government spending. As a result, the government will need to borrow to cover the shortfall. Also this week, the third and final credit rating agency downgraded U.S. debt. Recall that the U.S. has had a split rating since Moody’s first downgraded it in 2011, followed by Fitch in 2023, and now S&P this week.
Given the recent wave of uncertainty, the financial community is beginning to question its large allocations to U.S. financial assets. Figure 1 illustrates the long-term concerns emerging with financial markets participants, presenting the U.S. deficit as a percentage of GDP. The chart clearly shows the historical shift from decades of relative stability and occasional surpluses (highlighted in green and grey) to significantly larger deficits following the shocks of the Global Financial Crisis (GFC) and COVID-19. Unfortunately, the deficit has not improved since the end of the pandemic (red) and is expected to deteriorate further with this budget.
Figure 2 highlights growing concerns in the bond market. Both the federal deficit and the absolute level of debt have increased, and the 30-year bond yield has surpassed 5%. The market appears unconvinced that this level of borrowing is sustainable. At some point, the trajectory is likely to reach a tipping point. The U.S. President claims the bill will halve the deficit and boost economic growth to 5.2% over four years. However, as noted above, it appears markets do not find these projections credible.
“This means that” this is a long-term issue that will eventually need to be addressed. While there are various approaches to resolving it, we believe that, in the interim, the U.S. dollar will continue to weaken.
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