August 27, 2019
Paul Christopher, CFA, Head of Global Market Strategy
Brian Rehling, CFA , Co-Head of Global Fixed Income Strategy
Michelle Wan, CFA, Investment Strategy Analyst
Charlotte Woodhams, Investment Strategy Analyst
Spending, Borrowing, And The Public Debt
Spending and the debt limit deal
Congress recently passed a spending deal that suspends the federal debt ceiling through July 2021 and increases spending by $320 billion over the next 2 years.
- Lawmakers recently passed a spending deal that suspends the federal debt ceiling through July 2021 and increases spending by $320 billion over the next 2 years.
- We expect that the resolution of the debt ceiling issue and increased federal spending will be modest positives for U.S. equity markets in the short term.
- Over the long term, high government debt levels are likely to lead to low inflation, low bond yields, and lower returns in U.S. financial markets.
Spending has no limit
A bipartisan federal budget deal was recently passed that increases spending and suspends the debt ceiling through July 2021, well past the next election cycle. This agreement eliminates the threat of a federal debt default and the political brinkmanship that normally accompanies the debt ceiling debate. The spending increase passed by Congress will still need to be appropriated to keep the federal government open past October 1—but the federal spending deal and agreements to avoid poison pill language in the appropriations bill make the prospects of a government shutdown relatively low.
The deal passed this summer effectively puts fiscally conservative lawmakers on the defensive and permanently removes the threat of sequestration that was agreed to by lawmakers in the Budget Control Act of 2011. The budget deal boosts U.S. federal spending by $320 billion over 2 years and increases discretionary spending to more than $1.3 trillion.
Over the past two years, we have seen a significant increase in U.S. deficit spending—both on an absolute basis and relative to gross domestic product (GDP)—due to tax reform. The latest agreement to boost discretionary spending will continue this trend. It is unusual to see legislators ramp up spending during periods of healthy economic activity, since significant increases in fiscal deficits are often reserved for periods of economic weakness as a tool to pull economies out of recession. Regardless of economic timing, in the short run, both the economy and politicians can benefit from deficit spending. Thus, federal spending is a popular tool for those looking to appeal to voters’ interests. As we move toward a presidential election year in 2020, the motivation to keep U.S. economic growth on a positive trajectory is clear.
Increased U.S. deficit spending is likely to have longer-term consequences for investors. It is impossible to predict exactly how much federal debt the country could bear before investors start to lose faith in the U.S. government’s fiscal accountability. Our expectation is that the U.S. can support a meaningfully higher federal debt level than it has today, given the country’s dominant global economic position and the U.S. dollar’s stance as the world’s reserve currency. But even if a U.S. fiscal crisis is not imminent, the consequences of significant national debt are likely to be real and far-reaching for investors.
Rapidly rising federal spending and debt levels can translate to:
A “crowding-out” effect — A large amount of federal borrowing and debt issuance leads to a greater portion of investment capital being diverted to Treasury debt from private borrowing and investment. A smaller pool of capital available for private investment could lower economic output and incomes.
Decreased fiscal flexibility — An increasing level of federal debt could restrict policy makers’ ability to respond to unexpected events. Whether future shocks are economic, geopolitical, or natural, they may have a more significant negative economic impact as lawmakers lack the flexibility to fiscally deal with such a crisis.
Borrowing costs — There are many reasons to expect interest rates to remain low for an extended period of time—even as U.S. government debt grows. If Treasury yields were to materially increase, the added interest cost would require increasing federal revenues, reduced spending, or some combination of both.
While it might not be popular in Washington, D.C., significantly slowing the pace of federal spending and debt growth could help the U.S. to reduce its reliance on unsustainable long-term debt trends. Yet, this development does not seem likely today as the most recent federal spending deal actually takes the country in the other direction. The federal spending deal may help to sustain U.S. economic growth in the short term, but over the longer term, high debt levels can lead to lower inflation, low bond yields, and lower U.S. financial-market returns for investors. For more information about the debt and deficit, please ask your financial professional for a copy of our report “Paying America’s Bills”.1