No consolidation
US federal government fiscal deficit was 6.4% of GDP in year ending September 2024, much higher than pre-pandemic levels. Federal debt held by the public is just below 100%. Even before factoring in the income tax cuts (currently passed by the House and to be debated in the Senate), there was no consolidation in sight. Net interest spending, which recently surpassed spending on defense and Medicare, was projected to rise further from 3.2% to 4% in 2034.
And added burden from extension of the 2017 Tax Cuts and Jobs Act (aka ‘One Big Beautiful Bill Act’)
Moody’s Ratings recently downgraded US sovereign rating from Aaa to Aa1. It expects federal deficit at 9% and federal debt at 134% by 2035, with interest spending absorbing ~30% of revenue, assuming the tax cuts get extended. It noted ‘While we recognize the US’ significant economic and financial strengths, we believe these no longer fully counterbalance the decline in fiscal metrics.’.
A scenario analysis by the Congressional Budget Office (CBO) in March projected the deficit at 6.6% in 2027 and 7.7% in 2034, if the tax cuts are extended. Higher interest rates could make this 8.5% in 2034.
The Committee for a Responsible Federal Budget (CRFB) estimates the deficit even higher, at 7% in 2027 and 7.8% in 2034 (latter if certain tax-cut-expirations built in now are cancelled as widely expected). The current administration has often spoken about deficit reduction (3% target as per the Treasury Secretary) through higher growth. This seems improbable even with the 2.6% real GDP growth assumed in the bill, an unlikely average over the next 10 years vs. the Fed’s longer run rate of 1.8% and given the likelihood of a moderation ahead in growth. Even then, the deficit will be 6%+ in 2027 and 2034.
Creates an unsustainable fiscal trajectory
Investors are currently demanding a higher premium for holding longer term US treasury bonds. However, the direct and
indirect hit (latter through uncertainty) to growth, and expectation of more rate cuts by the Fed if growth falters
faster/stronger, should eventually lead to lower rates. The US Dollar could extend its weaker run, given the heavily
overweight position in US assets and the likely need for diversification.
Source for the chart: CBO, Bandhan MF Research
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