The rise in individual income tax receipts has been relentless, suggesting that the federal budget deficit for FY22 will significantly undershoot the CBO’s latest forecast of $1.036tr. Nevertheless, the CBO sent a clear message in its latest Budget and Economic Outlook: ‘smaller’ deficits in FY22 and FY23 do little to alter the path for the debt burden thereafter.
The US is still set to run budget deficits averaging 5.1% of GDP between 2023-2032, eventually reaching 6.1% at the end of this 10-year period. This is far in excess of the average annual deficit of 3.5% of GDP over the past 50 years.
A growing portion of the deficit will be taken up by government net interest outlays, set to rise to 3.25% of GDP by 2032, surpassing the previous peak of 3.19% of GDP in 1991. But this assumes a very moderate climb in the 10-year Treasury yield to 3.8% by 2032. As such, the US is exposed to a sharp move higher in interest rates. Yesterday’s rise in Treasury yields underlined the risks, with the 10-year yield jumping back up to 3.04% again, nearing the highs of early-May (3.12% on May 6th).
Governments worldwide are caught up in a debt ‘trap’. QE was necessary during the financial crisis of 2007/08. It was arguably critical when the coronavirus pandemic hit in 2020 too. But in the intervening years, little effort was made to wean economies off central bank support. Now governments are overly exposed to higher sovereign bond yields, which are rising again globally, with further increases in 10-year Bund and Gilt yields yesterday.
The yen is testing new secular lows too, not helped by the Reserve Bank of Australia’s larger-than-expected 50 basis point rate hike. Even a small rise in the effective yield cap may trigger a wave of JGB selling: the BoJ’s resolve to defend any target will be put to the test.
