Trillions
I have been on TV quite a bit recently and two topics of conversation have dominated the discussion. These are the performance of US equities and the path of US interest rates based on inflation.
In both cases, I have been pretty bullish my thinking being that US stocks are likely to continue higher until the year-end and that inflation in the US has been, or is close to being tamed.
This means that the Federal Reserve shouldn’t have to raise interest rates any further, add to that the possibility of a soft landing, or even no landing at all for the US economy, and you almost have the makings of a Goldilocks moment.
A frightening undertone
However, as with all fairytales, there is an underlying menace in the story a not-so-hidden danger that many people seem happy to ignore.
Back in May, I wrote about the US debt ceiling and what that meant for the American economy, see the link below:
https://www.activtrades.com/en/news/what-is-the-us-debt-ceiling-and-why-is-it-an-issue%3F
That issue was kicked down the road by politicians in Washington DC until after next year's presidential election.
And whilst we don’t have to worry about the possibility of the US government running out of money in the next 16 months, that doesn't mean that the country's finances are not an issue of concern.
Especially when you see headlines such as the ones posted by Bloomberg on July 31st
Which read as follows:
“US Treasury Boosts Quarterly Borrowing Estimate to $1 Trillion”
“The Department had previously estimated $733 billion for the quarter”
This article went on explain that this would be a record figure for borrowing in the September quarter and was well over what analysts at JP Morgan and other institutions had been forecasting.
Some of that increased borrowing will help to replenish the government’s cash pile known as the Treasury General Account, or TGA, which is effectively the cash with which the US federal government pays its day-to-day bills.
Deep in the red
The depletion of this account, before the cross-party agreement on the debt ceiling, was one of the reasons that traders were concerned about the possibility of a technical default.
Looking at the data and comments that accompanied the borrowing estimates, from the Department of the Treasury, analysts at JP Morgan have calculated that the US Budget deficit will run to $1.80 trillion by the fiscal year-end (October 2023).
The deficit is the difference between the government's spending commitments and the revenue it raises through taxes and other payments.
You can think of the deficit as being a bit like an overdraft, money the govt borrows to smooth out cash flow until the “end of the month”
This shortfall is not a one-off either as we can see in this chart, which shows budget deficits from 2019 to the current date
Bipartisanpolicy.org
Now large as this year's deficit is it's far smaller than those incurred during the pandemic, which climbed to more than $3.0 trillion.
Paying for the privilege
Some of that borrowing will of course be paid for by tax receipts raised from consumers and companies in the US. But the excess is funded through debt issuance or in plain English the US government borrows money from the bond markets to pay for its spending, and it's been doing that for some time.
That goes some way to explain the dramatic rise in the level of US national debt since the year 2000 which we can see below.
This debt now stands at $32.66 trillion and rising. Not only is the size of the absolute debt rising sharply but so is the size of the debt pile relative to US GDP, or Gross Domestic Product. Effectively what the country earns each year, we can see that change below.
In fact, the US has the 3rd highest debt-to-GDP ratio in the developed world behind Japan and Italy. The ratio for the US is 129% meaning that the US owes almost 30% more money than it generates in a year.
Now like any debt or loan, US govt borrowings need to be serviced, and the cost of servicing the debt is rising, simply because the debt pile is growing and US interest rates have been moving higher.
Getting out of control?
According to research conducted by Bloomberg, the cost of interest payments on US debt in the first 9 months of the fiscal year 2023 was $652 billion. What's more the weighted average interest rate on that debt pile has risen to 2.76%, up from 1.80% the year before.
That average rate is likely to rise further, as bonds that were issued when rates were far lower, mature and the debt has to be replaced, with further borrowing at current rates.
We can see just what those rates are in the table below.
So the problem is only going to get worse. And although the debt ceiling issue has “gone away“ we can look forward to plenty of debate and horse trading on Capitol Hill, when budget negotiations for 2024 get underway on October 1st.
Real-world Impacts
Rising US borrowing costs have meant that the US Dollar has decreased in value this year.
A move which goes against the economic orthodoxy of money flowing to where it can get the highest returns.
The dollar vs US 3-year yields
Trading Economics
And that suggests to me that the markets are worried about the outlook for US finances over the medium term of 3 to 5 years and maybe even over the longer term too.
Turns out the market is not alone: On Tuesday (01/08/23) rating agency Fitch downgraded its credit rating on US government debt to AA+ from the coveted AAA rating it had previously enjoyed.
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