US debt levels are reaching ever-scarier levels, and important people are starting to ask questions.
- On current rates, up to one-third of tax receipts could be absorbed by debt repayments by the end of the decade.
- Successive presidents have been able to rely on a broad global appetite for US debt, but this is evaporating.
- Foreign investors have typically been willing buyers of US treasuries, but have reduced their participation in treasury auctions.
The clamour over the US fiscal deficit is growing louder. This week was the turn of Phillip Swagel, director of the Congressional Budget Office, who said the country’s debt was on an “unprecedented” trajectory and risked a crisis akin to that seen during the Liz Truss Budget in 2022. The consequences for the world’s financial markets would be significant.
There are a number of reasons to worry. The first is the disinclination of either presidential candidate to tackle the problem. Donald Trump is keen for tax cuts, while Jo Biden wants more spending. Both strategies would raise debt levels still further. On current rates, up to one-third of tax receipts could be absorbed by debt repayments by the end of the decade .
Successive presidents have been able to rely on a broad global appetite for US debt – either from international buyers or its own central banks. This has kept yields low, but there are threats to this benign borrowing environment. The Federal Reserve is no longer the buyer of last resort. Strains are showing in the repo market, which is a bellwether for banking sector liquidity. The US Fed’s reverse repo facility (RRP) has provided a cushion, helping absorb the huge treasury issuance, but is being rapidly depleted. There is a question over who will buy US treasuries when the RRP balance is depleted.
Foreign investors have typically been willing buyers of US treasuries, but have reduced their participation in treasury auctions over the past couple of years as their domestic bond markets have become more attractive. The Japanese, for example, had previously been significant buyers of US treasuries, but as their domestic interest rates rise, they may switch their attention to their local bond market. In the case of China, geopolitical tensions have weakened appetite for US debt.
The situation appears precarious. If buyers melt away for US debt, it will raise treasury yields and act as a de facto interest rate rise. This could spell bad news for the US economy. Emma Moriarty, investment manager at CG Asset Management (CGAM) suggests three possible routes out of the crisis: “The obvious answer would be to run persistent fiscal surpluses. But despite increasingly polarised politics in the US, there is no obvious constituency in favour of fiscal probity.”
The other option, she says, is for the US economy to grow its way out of the debt, but high debt and real interest rates makes this difficult. “The last option – and perhaps the only practical option over the medium term – is for governments and central banks to allow higher rates of inflation to persist, and in doing so, erode the value of the debt in real terms.” Higher inflation may be the ultimate consequence of any US debt crisis.
