As Congress prepares to debate whether to extend the 2017 Trump tax cuts, the unsustainability of the U.S. fiscal position is coming into focus.
The ratio of federal debt to the size of the U.S. economy is set to reach a record 116% in 2034, surpassing levels seen during World War II, and is on track to hit 172% of GDP by 2054, according to the Congressional Budget Office.
Whether or not markets can absorb the new issuance of Treasury bonds BX:TMUBMUSD10Y needed to finance the U.S. government’s operations is an open question, according to Torsten Slok, chief economist at Apollo Global Management and Michael Feroli, chief economist at J.P. Morgan.
The Wall Street economists argued Monday during a panel on the U.S. fiscal situation staged by the American Enterprise Institute that another economic recession in the U.S., which would increase deficits and debt even more than projected, could be a catalyst for a U.S. debt crisis that would send shockwaves through global financial markets.
Feroli said the constrained capacity of large banks to house U.S. government debt on its balance sheets, in part due to post-financial crisis regulations, puts Treasury markets on shaky footing in a scenario where a recession causes an unexpected spike in debt issuance.
“There’s a concern here, not just that the Treasury would have to issue more in a recession, but that there isn’t the infrastructure that could intermediate that issuance in a way that would guarantee that we don’t have some problems, perhaps, that echo what happened with Liz Truss’ mini-budget two years ago,” Feroli said, referring to turmoil in markets for U.K. government debt triggered by plans for unfunded tax cuts.
Apollo’s Slok pointed to the evolving profile of purchasers of Treasurys as another potential reason for worry, as pension and insurance companies have begun to gobble up new issuance, attracted by high interest rates.
These buyers have replaced foreign governments, like China, which had been buying a large share of Treasury bonds in an effort to strengthen the dollar and support exports to the U.S., Slok said.
“We’re shifting from a yield insensitive buyer to a yield sensitive buyer,” Slok said, adding that if the Fed were to cut interest rates in a recession, demand for U.S. Treasurys could fall quickly.
“If you have a rising debt level and you have a pretty significant deficit,” Slok added, ”then your vulnerability in case of a shock is just higher than normal.”
