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Skyrocketing debt and deficits are raising concerns about threats to the economy and markets.

Skyrocketing debt and deficits are raising concerns about threats to the economy and markets.

A view shows the United States Capitol in Washington, United States, May 9, 2024.

Kaylee Greenlee Beal | Reuters

The public debt, which has swelled by almost 50% since the first days of the Covid pandemic, is causing great concern both on Wall Street and in Washington.

The federal IOU now stands at $34.5 trillion, about $11 trillion more than in March 2020. As a share of the total U.S. economy, it now represents more than 120%.

Concern over such staggering numbers was largely limited to partisan rancor on Capitol Hill as well as that of watchdog organizations like the Committee for a Responsible Federal Budget. However, in recent days the debate has spread to government and financial heavyweights, with even a major Wall Street firm questioning whether the costs associated with debt pose a significant risk to the stock market recovery.

“We have large structural deficits, and we’re going to have to deal with them sooner or later, and sooner is much more attractive than later,” Fed Chairman Jerome Powell told an audience of bankers at Amsterdam. .

Although he assiduously avoided commenting on such issues, Powell encouraged the audience to read the Congressional Budget Office’s recent reports on the nation’s fiscal situation.

“Everyone should read what they publish about the U.S. budget deficit and should be very concerned that elected officials need to address it as soon as possible,” he said.

Uncharted territory for debt and deficits

Indeed, the CBO figures are worrying, because they describe the likely evolution of debt and deficits.

The watchdog agency estimates that debt held by the public, which currently stands at $27.4 trillion and excludes intragovernmental obligations, will rise from the current 99% of GDP to 116% over the next decade. That would be “a larger amount than at any time in the nation’s history,” the CBO said in its latest update.

Growing budget deficits have fueled the debt, and the CBO expects the situation to only get worse.

The agency projects a deficit of $1.6 trillion in fiscal year 2024 – it already stands at $855 billion in the first seven months – which will reach $2.6 trillion by 2034. percentage of GDP, the deficit will increase from 5.6% this year to 6.1% in 10 years.

“Since the Great Depression, deficits have only exceeded this level during and shortly after World War II, the 2007-2009 financial crisis, and the coronavirus pandemic,” the report said.

In other words, such high deficit levels are common primarily in periods of economic downturn, not in the relative prosperity that the United States enjoyed for most of its period after the brief slump that followed the declaration of the pandemic in March 2020. From a global perspective, European Union member countries are required to maintain deficits at 3% of GDP.

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The potential long-term consequences of the debt were the subject of a Sky News interview with JPMorgan Chase CEO Jamie Dimon on Wednesday.

“America should be aware that we need to focus a little more on our budget deficit problems, and that’s important for the world,” said the head of the largest US bank by assets.

“At some point this is going to be a problem and why should you wait?” » added Dimon. “The problem will be caused by the market and then you will be forced to deal with it and probably in a much more uncomfortable way than if you had done so in the first place.”

Similarly, Bridgewater Associates founder Ray Dalio told the Financial Times a few days ago that he was concerned that soaring U.S. debt levels would make Treasuries less attractive, “particularly for international buyers worried about the US debt situation and possible sanctions.

So far, that hasn’t been the case: Foreign holdings of U.S. federal debt stood at $8.1 trillion in March, up 7% from last year, data shows of the Treasury Department released Wednesday. Risk-free Treasuries are still seen as an attractive place to store cash, but that could change if the U.S. doesn’t get its finances under control.

Market impact

More immediately, there is concern that rising bond yields could spill over into equity markets.

“The obvious problem is that U.S. federal debt is now on a completely unsustainable long-term trajectory,” Wolfe Research analysts said in a recent note. The company fears that “bond vigilantes” will go on strike unless the United States gets its fiscal house in order, while rising interest costs crowd out spending.

“Our sense is that policymakers (on both sides) will not be willing to seriously address America’s long-term fiscal imbalances until the market begins to take firm stand against this untenable situation,” write the Wolfe analysts. “We believe that policymakers and the market are most likely underestimating projected future net interest costs.”

Interest rate hikes by the Federal Reserve have complicated the debt situation. From March 2022 to July 2023, the central bank raised its short-term borrowing rate 11 times, for a total of 5.25 percentage points, a policy tightening that corresponded with a sharp rise in Treasury yields.

Net debt interest, which totals public debt repayments minus investment income, totaled $516 billion this fiscal year. That’s more than the government spent on national defense or Medicare and about four times more than it spent on education.

The presidential election could have modest consequences on the budgetary situation. The debt soared under President Joe Biden and intensified under his Republican challenger, former President Donald Trump, following the aggressive spending response to the pandemic.

“The elections could change the medium-term fiscal outlook, but potentially less than one might imagine,” Goldman Sachs economists Alec Phillips and Tim Krupa said in a note.

A Republican sweep could lead to an extension of the corporate tax cuts Trump imposed in 2017 – corporate tax revenues have nearly doubled since then – while a Democratic victory could lead to increases taxes, even if “a large part of these reductions would probably be devoted to new spending”. ” said Goldman economists.

However, the budget’s biggest problem is spending on Social Security and Medicare, and “in no scenario” regarding the election does reform of either program seem likely , Goldman said.

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