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Why we need to talk about the US budget deficit?
Summary: We may not have reached the inflection point where the marginal risk-reward favours bears more than bulls just yet, but we are getting ever so close to that moment of truth.
We are at a critical stage of the market cycle with multiple headline risks opening up a wide array of possibilities from here. Will US-China trade war escalate further or end in a sooner-than-anticipated truce? Will the Federal Reserve march ahead with its projected dot plot hikes into 2019 or pause after the December hike? How long will the likely EU-Italy collision on the Italian budget issue last? Will there be a Brexit deal before the close of the year or will both parties borrow more time for negotiation by extending the transition period by another year? Will Theresa May survive as PM through all these uncertainties? What is going on with Saudi Arabia? Is Trump going to penalise Riyadh for an extraordinary overreach of power or use it as a bargaining chip to get the Saudis to increase crude production and drive oil prices down? All these questions have massive implications depending which way the tide turns.
But underneath the headline agendas, there is a substantial risk floating slightly under the market’s radar which is following a structural trend with little hope of any dramatic correction – the big, booming US budget deficit.
- The budget deficit published last week for the preceding 12 months widened to alarming levels of $779 billion -a whopping increase of $113bn (a 6-year high) that constitutes 3.9% of GDP
- This is a not merely the result of Trump’s tax cuts from last year but a more structural problem of unsustainable debt building over many years that was nonetheless exacerbated sharply by the tax cuts
- Although the official Treasury estimates differ from more independent estimates for 2019 and 2020, the trend is likely to continue. The Congressional budget office forecasts a budget deficit of 973bn for 2019 and more than €1 trillion for 2020 – which would mark the first time the deficit breaches the $1tn mark since 2012 when the US economy was at a nascent stage of recovery from the great financial crisis.
- The interest payments alone have crossed $500bn for the year ($523bn).