Rising debt and deficits cause concern about threats to the economy and markets

Government debt, which has ballooned by nearly 50% since the early days of the Covid pandemic, is generating high levels of anxiety on both Wall Street and Washington.

Federal debt securities are now worth $34.5 trillion, or about $11 trillion higher than they were in March 2020. As a fraction of the total US economy, they are now more than 120%.

Concern about these staggering numbers has been largely confined to partisan rancor on Capitol Hill as well as from watchdogs like the Committee for a Responsible Federal Budget. However, in recent days, the chatter has spread to government and financial heavyweights, with one prominent Wall Street firm even questioning whether debt-related costs pose a significant risk to the stock market's rise.

“We are running a large structural deficit, and we are going to have to deal with this sooner or later, and sooner is more attractive than later,” Federal Reserve Chairman Jerome Powell said Tuesday to an audience of bankers in Amsterdam. .

While Powell avoided commenting on such matters, he encouraged the public to read the Congressional Budget Office's recent reports on the country's fiscal situation.

“Everyone should read the things they post about the US budget deficit, and should be very concerned that this is something elected officials need to come to terms with sooner rather than later,” he said.

Indeed, the central bank numbers in Congress are ominous, because they outline the likely path of debt and deficits.

The watchdog estimates that debt owed by the general public, which currently totals $27.4 trillion and excludes internal government liabilities, 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 Congressional Budget Office said in its latest update.

The high budget deficit has exacerbated debt, and the Congressional Budget Office expects it to get worse.

The agency projects a $1.6 trillion deficit in fiscal year 2024 — already reaching $855 billion during the first seven months — which will rise to $2.6 trillion by 2034. As a share of GDP, the deficit will grow from 5.6% this year to 6.1%. Within 10 years.

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

In other words, such high deficit levels are mostly common in periods of economic recession, not the relative prosperity that the United States enjoyed throughout most of the era after the brief decline following the announcement of the pandemic in March 2020. From a global perspective, the member states of the E.U. What is required is to keep the deficit at 3% of GDP

The potential long-term ramifications of debt were the subject of an interview that JPMorgan Chase CEO Jamie Dimon gave to London-based Sky News on Wednesday.

The head of the largest US bank by assets said: “America must fully realize that we have to focus on our fiscal deficit issues a little more, and this is important for the world.”

“At some point it's going to cause trouble, and why should you wait?” Damon added. “The problem will be caused by the market, and then you will have to deal with it, perhaps in a much more uncomfortable way than if you had dealt with it initially.”

Likewise, Ray Dalio, founder of Bridgewater Associates, told the Financial Times a few days ago that he was concerned that rising US debt levels would make Treasuries less attractive “particularly from international buyers concerned about the US debt picture and potential sanctions.”

So far, that has not been the case: Foreign holdings of U.S. federal debt reached $8.1 trillion in March, up 7% from a year ago, according to Treasury Department data released Wednesday. Risk-free Treasuries are still considered an attractive place to park cash, but that could change if the United States doesn't rein in its finances.

Immediately, there are concerns that the rise in bond yields will spill over into equity markets.

“The obvious big problem is that US federal debt is now on a very unsustainable long-term path,” analysts at Wolff Research said in a recent note. The company is concerned that “bond vigilantes” will go on strike unless the US can get its fiscal house in order, while rising interest costs crowd out spending.

“Our feeling is that policymakers (on both sides) will not be ready to address long-term U.S. fiscal imbalances in a serious way until the market begins to aggressively confront this unsustainable situation,” Wolf analysts wrote. “We believe that policymakers and the market are likely underestimating expected future net interest costs.”

Interest rate hikes by the Federal Reserve have complicated the debt situation. From March 2022 through 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 interest on debt, which represents a government's total debt payments minus what it receives in investment income, was $516 billion this fiscal year. This is more than government expenditures for national defense or Medicare and about four times what it spent on education.

It is possible that the presidential elections will make some modest differences in the financial situation. Debt has risen under President Joe Biden and escalated under his Republican rival, former President Donald Trump, in the wake of the aggressive spending response to the pandemic.

“The election could change the medium-term fiscal outlook, although it may be less than one might imagine,” Goldman Sachs economists Alec Phillips and Tim Krupa said in a note.

A GOP sweep could extend the expiring corporate tax cuts that Trump pushed through in 2017 — corporate tax revenues have doubled since then — while a Democratic win could see tax increases, though “most of this is likely to It goes toward new spending,” Goldman economists said.

However, the biggest budget problem is spending on Social Security and Medicare, and reform in neither program “under any scenario” regarding elections seems likely, Goldman said.