What, Me Worry? – The Alfred E. Neuman Fiscal
Strategy
By the Curmudgeon with Victor
Sperandeo
Introduction:
In last week’s column - Curmudgeon: Yielding to
Reality: The Bond Market Rejects Tariff Optimism and Wall Street Euphoria -
we described the problems facing the U.S. government bond market, most notably
the ever increasing budget deficits which have created a supply/demand
imbalance and an increasing risk premium.
While the S&P and other stock
indexes had a terrific week, U.S. bonds remained in the doldrums. That’s
despite very bullish news for bonds and five
consecutive day advances for the S&P 500:
1. The CPI and PPI prints
are coming in well below analyst forecasts:
A] The Consumer Price Index (CPI)
for All Urban Consumers rose 0.2% seasonally adjusted and rose 2.3% over the
last 12 months.
B] The Producer Price Index (PPI)
for final demand fell -0.5% in April, seasonally adjusted. Final demand prices
were unchanged in March and increased 0.2% in February.
2. The University of Michigan’s consumer confidence
index was at a multi-year low at 50.2 (down from 52.2 in April and now at
the second lowest level ever recorded).
Lower consumer confidence augurs for a weakening economy and lower
interest rates.
3. Consumer spending is
~68.5% of GDP as per Q1-2025. In
this month’s survey, 38% of consumers are prepared to forgo purchases due to
tariff induced price increases. That share rises to nearly half (46%) among
those living paycheck to paycheck.
Decreased consumer spending increases the probability of a recession
which has always lowered interest rates across the board.
U.S. Treasury yields ignored that
news and rose past significant undesirable milestones last week as the 10-year Treasury
note topped 4.5% and the 30-year bond yield hit 5% intra-day before settling at
4.954% on Friday, May 16th.
The 5% mark on the U.S. long bond was briefly breached in October 2023
before the Treasury backed away from plans to boost longer-term borrowing. It hasn’t been seen on a sustained basis
since before the financial crisis in 2008-2009.
U.S. Debt Downgraded by
Moody’s:
Late Friday, Moody’s Investors became
the last of the major raters to strip U.S. government bonds of its AAA rating
to Aa1. The downgrade was “driven mainly
by increased interest payments on debt, rising entitlement spending, and
relatively low revenue generation.” Moody’s
wrote in a statement:
“This one-notch downgrade on our
21-notch rating scale reflects the increase over more than a decade in
government debt and interest payment ratios to levels that are significantly
higher than similarly rated sovereigns.”
“Successive U.S. administrations
and Congress have failed to agree on measures to reverse the trend of large
annual fiscal deficits and growing interest costs. We do not believe that
material multi-year reductions in mandatory spending and deficits will result
from current fiscal proposals under consideration.”
Moody’s said it expects deficits
to reach nearly 9% of GDP by 2035, up from 6.4% in 2024. Does anyone think
that is sustainable? Note that Standard
& Poor’s and Fitch Ratings previously demoted Uncle Sam’s debt by one notch,
so there are no credit rating agencies that award the U.S. with a AAA rating.
Speaking on NBC’s Meet the
Press with Kristen Welker, U.S. Treasury Secretary Scott Bessent
addressed the Moody’s Ratings downgrade of the U.S. credit outlook: “Moody’s is
a lagging indicator. That’s what everyone thinks of credit agencies. We didn’t get here in the past 100 days. It’s the Biden
administration and the spending that we have seen over the past four years that
we inherited. We are determined to bring
the spending down and grow the economy.”
FAT CHANCE!!!
Deutsche Bank economists wrote, “In short, there appears to be no
serious effort at reining in historically elevated deficits, which remain on
track to exceed over 6% of GDP in the coming years.”
Tax Bill Would Increase
Deficits; Worsen Supply/Demand Imbalance:
President Trump’s “big,
beautiful tax bill” to extend the 2017 tax cuts, due to expire at year-end,
would make the federal budget deficits much, much worse. That proposed bill
from the tax-writing House Ways and Means Committee was rejected by five House
Republicans who were holding out for a bigger expansion of the state and local
tax deduction, otherwise known as SALT.
Of course, the U.S. bond market has to fund those sky-high budget deficits via the Treasury
Department auctions of government securities.
-->That’s the essence of the supply/demand imbalance.
The Joint Committee on Taxation
estimated that the bill, including the renewal of the Tax Cut and Jobs Act
of 2017, would increase U.S. budget deficits by $3.8 trillion through 2034,
equal to 1.1% of GDP. If the bill was
extended, the Bipartisan Policy Center estimated that the deficit would
be $5.3 trillion higher, or 1.5% of GDP, even including some $2 trillion in
spending cuts through 2034.
The Penn Wharton Budget Model says
the bill would increase the “primary” deficit by $6 trillion over 10 years. The
so-called primary deficit excludes interest costs, focusing only on spending on
programs.
The additional red ink would be
added to the current U.S. budget deficit of $2 trillion/year, or close to 7% of
GDP—a level only approached during recessions or wartime!
Senate Minority Leader Chuck
Schumer, said Moody’s action “should be a wake-up call to Trump and
Congressional Republicans to end their reckless pursuit of their
deficit-busting tax giveaway.”
“Sadly, I am not holding my breath
— today’s GOP simply does not care about deficits or our nation’s fiscal
health,” he said in a statement. “Republicans are hell-bent on a multi-trillion
tax cut for the ultra-wealthy, leading to nothing but higher prices, more debt,
and fewer jobs.”
According to Mizuho economists
Steven Ricchiuto and Alex Pelle: “The prospects of a large tax cut add to our
view that interest rates at both ends of the yield curve will end the year
decidedly higher than they are today.”
And the risks are rising. “Our
view is that the nation is headed for a fiscal crisis because the economy
cannot sustain budget deficits this big,” writes Carl Weinberg, chief economist
at High Frequency Economics. “At some point, markets will rebel against
unsound fiscal practices, and that includes the wisdom of cutting taxes and
increasing the fiscal deficit when the economy is at full employment already,
especially if it boosts the public sector debt to more than 100% of GDP,” he
added.
Debt Service Expense Will
Rise with Higher Deficit and Rates:
The current U.S. debt service cost
this year includes $579 billion in net interest payments, which puts the United
States on track for the highest annual interest bill in its history.
As of 2024, the U.S. debt service
cost was 3.02% of GDP. This percentage has been rising due to increasing debt
levels and higher interest rates. In 2023, the cost was around 2.5% of GDP, and
projections suggest it could reach 3.9% by 2034. The costs of financing the
U.S. national debt is becoming much more of a problem
now as old U.S. notes and bonds sold during the ultra-low-interest-rate era
following the 2008-09 financial crisis are refinanced with the current 4%
coupons.
As noted in many previous
Curmudgeon/Sperandeo posts, the U.S. government’s interest expense is
the fastest-growing part of the budget and can NOT be cut by DOGE or
Congress! It is now greater than U.S.
defense spending.
Victor’s Comment:
In the 54.33 years since the U.S.
went off the gold standard in 1971, U.S. debt has been trending upwards at a
+8.7% annual rate. Yet GDP is increasing at a 2.5% annual rate during the same period.
This implies that the Debt- to- GDP ratio will go from the current 1.23:1 to
2.:24 to 1 in 10 years.! It appears the U.S. government has adopted Alfred E.
Newman’s “WHAT ME WORRY” as per this MAD magazine cover:
Term Premium Has Increased:
The term premium—the extra yield
demanded by investors to compensate for the risk of holding longer
maturities—has increased as we noted last week and is corroborated by BCA
Research. The increase is due to the
large fiscal deficits and the pullback by overseas investors owing to concern
over Treasuries’ safe-harbor status during the first four months of the Trump
administration.
Blackrock
analysts Simon Wan and Tom Becker write, “Without a larger “term premium”
to compensate investors for bearing longer-term economic risks, it will be
challenging to get Americans to increase the maturity profile of their fixed
income holdings.”
Long-end US Treasuries
offer a meager yield uplift and rising portfolio risk:
Conclusions:
The 22V Research team led
by Dennis DeBusschere says a further rise in longer-term Treasury yields would
pose a “headwind” for risk assets, with 4.7% on the 10-year as a level seen by
investors as “obviously problematic for the economy.”
Raymond James analysts Tavis C. McCourt and David Vargas write
that the 4.5% on the benchmark 10-year Treasury has been an important marker
for the stock market since 2021. Above 4.7% “has been death for equities with
almost nothing working across any index as the equity market starts pricing in
recession.”
Increased supply coupled with
lower demand suggests that the U.S. government will have to pay more to borrow
to cover the current deficit and to roll over older, low-interest rate debt.
That poses a huge problem for fixed income investors like the
Curmudgeon.
Rinse and repeat:
Higher budget deficits → Increased
supply of Treasuries --> Higher interest rates → Higher debt service
costs → More debt issuance → Even higher interest rates.
….……………………………………………………………………………………………………………………..
Good health, success, good
luck and till next time………………………………………
The Curmudgeon
ajwdct@gmail.com
Follow the Curmudgeon on Twitter @ajwdct247
Curmudgeon is a retired investment professional. He has been involved in financial markets since 1968 (yes, he cut his teeth on the 1968-1974 bear market), became an SEC Registered Investment Advisor in 1995, and received the Chartered Financial Analyst designation from AIMR (now CFA Institute) in 1996. He managed hedged equity and alternative (non-correlated) investment accounts for clients from 1992-2005.
Victor Sperandeo is a historian, economist and financial innovator who has re-invented himself and the companies he's owned (since 1971) to profit in the ever-changing and arcane world of markets, economies, and government policies. Victor started his Wall Street career in 1966 and began trading for a living in 1968. As President and CEO of Alpha Financial Technologies LLC, Sperandeo oversees the firm's research and development platform, which is used to create innovative solutions for different futures markets, risk parameters and other factors.
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