US fiscal profligacy: How much to worry?

In Short

The unexpected decision by Fitch to cut the US government top rating to AA+ brought the US’ challenging fiscal outlook top of mind. Fiscal policy is highly procyclical Despite unemployment close to record lows, the fiscal deficit soared to 8.6% in Q2 (12 mth. rolling basis), doubling from the same period last year and reaching levels only seen during the Great Financial Crisis over the past decades.

Highlights:

  • After the last-minute deal on the US debt ceiling in May, the recent downgrade by Fitch and a larger-than-expected bond issuance have brought US fiscal concerns back into the spotlight.
  • The US fiscal deficit has soared to 8.6% of GDP, adding to US growth resilience but undermining the Fed’s inflation fight. A polarised Congress and the 2024 elections will prevent a meaningful policy shift. We expect federal debt to rise from just below 100% to 113% of GDP by 2033, only slightly below CBO estimates.
  • The “exorbitant privilege” of issuing debt in a reserve currency will ensure a high US rating for longer despite worrying fiscal metrics, with a poor handling of future debt ceiling extensions the most prominent risk.
  • High Treasury net supply will decline only slowly, raising the term premium somewhat further. Yet the yield impact will be largely outweighed by economic and key rate developments
     

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US fiscal profligacy: How much to worry?

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