Long-Run Effects of Budget/Debt Deal Are Not Investor-Friendly: Higher Rates and Taxes Are Coming
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The budget/debt ceiling negotiation ended like several others; a lot of drama but no fundamental change. The irony is that the primary goal of these negotiations, at the least from House negotiators, was to reduce the staggering debt load of the federal government. Yet, in the end, Congress again decided to vote for more debt, a lot of it, to pay for spending.
The Congressional Budget Office (CBO) projects that the US will run budget deficits between $1.5 to 2.0 trillion per year for the next decade, adding nearly $20 trillion to the federal government's outstanding debt.
Nearly two decades ago, CBO projected the US would run budget deficits in the $200 to $300 billion range, which alarmed former Fed Chairman Alan Greenspan. Back then, Mr. Greenspan stated, "When you begin to do the arithmetic of what the rising debt level implied by the deficits tells you, and you add interest costs to that ever-rising debt, at ever-higher interest rates, the system becomes fiscally destabilizing," he told lawmakers. " What would he say today?
The impact of budget deficits on interest rates varies depending on economic conditions. Yet, huge budget deficits for the foreseeable future will occur as the Federal Reserve reduces its balance sheet, removing the non-interest rate-sensitive buyer that has held down interest rates in the past several years. Market interest rates will have to go much higher to attract private sector buyers, and it would not be surprising if ten-year yields rise 100 to 200 basis points over current levels in coming years.
To balance the federal budget requires two things; first, cutting the entitlement programs, and second, raising taxes. Critics would argue against higher taxes, but balancing the budget with tax receipts equaling less than 20%-plus % of GDP (currently running at 18%) is impossible. And since individual tax payments represent a record 50%-plus of total taxes, while corporate tax payments are near a record low of 8%, business taxes are at risk of increasing.
In the past decade, investors have benefitted doubly from Congress's decision to use debt instead of taxes to pay for record spending and the Fed's record purchases of debt securities. Yet, that era is over. The debt deal maintains record federal borrowing, but now without the Fed as a (buying) partner. Investors should expect higher interest rates as a result. And once the higher debt costs become fiscally destabilizing, as Greenspan noted, Congress must move on taxes, with business taxes the target.
Joseph G. Carson
AuthorMore in Author Profile »Joseph G. Carson, Former Director of Global Economic Research, Alliance Bernstein. Joseph G. Carson joined Alliance Bernstein in 2001. He oversaw the Economic Analysis team for Alliance Bernstein Fixed Income and has primary responsibility for the economic and interest-rate analysis of the US. Previously, Carson was chief economist of the Americas for UBS Warburg, where he was primarily responsible for forecasting the US economy and interest rates. From 1996 to 1999, he was chief US economist at Deutsche Bank. While there, Carson was named to the Institutional Investor All-Star Team for Fixed Income and ranked as one of Best Analysts and Economists by The Global Investor Fixed Income Survey. He began his professional career in 1977 as a staff economist for the chief economist’s office in the US Department of Commerce, where he was designated the department’s representative at the Council on Wage and Price Stability during President Carter’s voluntary wage and price guidelines program. In 1979, Carson joined General Motors as an analyst. He held a variety of roles at GM, including chief forecaster for North America and chief analyst in charge of production recommendations for the Truck Group. From 1981 to 1986, Carson served as vice president and senior economist for the Capital Markets Economics Group at Merrill Lynch. In 1986, he joined Chemical Bank; he later became its chief economist. From 1992 to 1996, Carson served as chief economist at Dean Witter, where he sat on the investment-policy and stock-selection committees. He received his BA and MA from Youngstown State University and did his PhD coursework at George Washington University. Honorary Doctorate Degree, Business Administration Youngstown State University 2016. Location: New York.