Will the expanding US fiscal deficit derail things?

Last week I looked at the US economy noting its good GDP performance in 2023 and also the fiscal issue. The latter got a bit of an update as the week progressed. Here is the Congressional Budget Office.

In CBO’s projections, the federal budget deficit in fiscal year 2024 is $1.9 trillion. Adjusted to exclude the effects of shifts in the timing of certain payments, the deficit amounts to
$2.0 trillion in 2024 and grows to $2.8 trillion by 2034.

These matters have an element of nuance to them as well as the numbers. So we are left with the feeling that borrowing is not only high but getting higher.

That amount is $0.4 trillion (or 27 percent) larger than the agency estimated in its previous baseline projections,

Considering the previous forecast was in February there has been quite an increase in a short time.There are two main factors in the rises which are the various wars by proxy (Ukraine and Israel) and the student loan forgiveness programme. It reminds me of how prescient former US President Dwight D Eisenhower was.

 In the councils of government, we must guard against the acquisition of unwarranted influence, whether sought or unsought, by the military-industrial complex. The potential for the disastrous rise of misplaced power exists and will persist.

Returning to the numbers we have an ELO “higher and higher, baby” style theme.

The deficit is projected to increase to $2.9 trillion in
2034, $0.3 trillion more than the amount in the previous baseline. All told, the cumulative deficit over the
2025‒2034 period is now projected to total $22.1 trillion, which is $2.1 trillion (or 10 percent) more than
previously projected.

Relative Numbers

One of the questions for this week’s podcast involved the French fiscal deficit which has been 5.5% and 5.3% as a comparison.

Measured in relation to the size of the economy, this
year’s deficit equals 7.0 percent of gross domestic product
(GDP) in CBO’s projections.

So the US is running a looser policy than France and whilst we wait for the election there on current trends will continue to do so. Especially as France is likely to be constrained by EU rules.

The cumulative deficit for the 2025–
2034 period is projected to equal 6.2 percent of GDP.

Debt Costs

This is an issue we have been noting pretty frequently over the past year or so. Looking back there have been various phases starting with the Covid spending, then the higher cost of inflation-linked debt ( called TIPS in the US). Then we have the rises in bond yields where there have been ebbs and flows but the US has been paying 4% plus for a while.

In CBO’s projections, net interest outlays total $892 billion in 2024—surpassing discretionary outlays for
defense this year—and rise to $1.7 trillion in 2034,

Notice that they are excluding payments made to the Federal Reserve ( considered intra governmental) which means that reductions in its holdings or QT are an issue.

Measured in relation to the size of the economy, those outlays grow from 3.1 percent of GDP in 2024 to 4.1 percent in 2034, at which point they would nearly equal projected outlays for Medicare. Since 1974, net outlays for interest have averaged 2.1 percent of GDP.

There is an issue here which as I have explained in the past is like a snowball rolling down a hill where not much seems to happen and then you have an issue. A factor in play here is that higher bond yields are only a factor when you issue new debt. With the larger debt burden and fiscal expansionism that wheel is spinning pretty quickly a the moment. The CBO has a go at estimating what the relative factors will be.

In CBO’s projections, about two-thirds of the growth in net
interest costs from 2024 to 2034 stems from increases in
the average interest rate on federal debt, and one-third
reflects the larger amount of debt.

Treasury Secretary Yellen

There has been a factor offsetting the above as I pointed out on the 26th March.

The US has always been an outlier when it comes to the maturity profile of its debt. The Treasury’s recent shift to short-dated debt issuance is making that difference more acute. Most other countries have been using the past couple of years to issue at longer maturities… ( Robin Brooks)

The problem with such a policy is that you become more vulnerable to higher bond yields or any debt crisis because you have to refinance your debt more often. According to the Financial Times more of this strategy is planned.

But Jay Barry, co-head of interest rate strategy at JPMorgan, said the expanded deficit would require the US to issue an additional $150bn of debt in the three months before the fiscal year ends in September.

He added he expected most of the funds to be raised through Treasury bills, short-term debt instruments whose maturity ranges from one day to a year.

That means this.

Such a move would increase the total outstanding stock of Treasury bills — unredeemed short-term US debt — from $5.7tn at the end of 2023 to an all-time high of $6.2tn by the end of this year.

However as this is to make issuance easier I think the Financial Times rather loses the plot a bit here.

“It is likely that the share of Treasury bills as a share of total debt increases, which opens up the question of who is going to buy them,” said Torsten Slok, chief economist at Apollo. “This absolutely could strain funding markets.”

What I mean by that is there will be those willing to pick up around 5% on short-term debt. However, there is a price to pay in that should a crisis emerge you get ever more vulnerable to it.

Federal Reserve

The QT programme of the US Federal Reserve has been adding to the issue as it lets bonds it owns mature. So this month it has reduced the rate of this.

 Beginning on June 1, 2024, the Committee will reduce the monthly redemption cap on Treasury securities from $60 billion to $25 billion, maintain the monthly redemption cap on agency debt and agency mortgage-backed securities at $35 billion, and reinvest principal payments in excess of these caps into Treasury securities to roughly match the maturity composition of Treasury securities outstanding.

Comment

The problem with raising concerns about such an issue is that it is easy to be dismissed as a “financial terrorist” until the last moment before you are proven right. There will be future issues from all the borrowing and debt management, but how they play out depends on economic growth both nominal and real. What I mean by nominal is that whilst inflation hurts the state in terms of inflation-linked debt it gains more via taxes and the like which are boosted by inflation. Also we have another problem for economics 101 as this should lead to a weaker US Dollar whereas in terms of activity the Euro has been hit more and in terms of price the Japanese Yen has.

One area that has been a theme on here for many years is that they will never be able to reverse all the QE bond buying. As we are seeing some QT indigestion at a level of around US $7.5 trillion that theme is holding up well and remember at some point the US will have to issue longer-dated debt. Meanwhile as Star Wars would say from a place far far away….

June 24 (Reuters) – As she heads toward retirement at the end of the month, Federal Reserve Bank of Cleveland President Loretta Mester still believes the central bank needs to remain open to active sales of mortgage bonds as part of its ongoing efforts to reduce the size of its balance sheet.

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