U.S. Lawmakers’ Deficit Fears Not Mirrored in Bond Market
As the national debt has soared to more than $16 trillion from less than $9 trillion in 2007, U.S. borrowing costs have tumbled. The yield on the 10-year note touched a record low 1.379 percent on July 25, down from more than 5 percent in mid- 2007 before the financial crisis. The super-low yields have pushed rates for mortgages, car loans and corporate borrowing to historic lows.
The U.S. has financed four straight budget deficits of more than $1 trillion with historically low interest costs. Recent market movements show that lenders are uneasy because a recession may result from failing to avert the so-called fiscal cliff, and they have less immediate anxiety about the nation’s long-term structural budget challenges.
“The market is definitely not concerned about the U.S. becoming Greece,” Anthony Valeri, a market strategist in San Diego at LPL Financial which oversees $350 billion in assets, said in a telephone interview. Greece this year underwent the biggest sovereign restructuring in history as yields on its 10- year bonds soared to more than 30 percent.
Lenders seeking a safe investment in a slow world economy are more optimistic than policy makers are about the amount of room the U.S. has for future borrowing. The budget talks in Washington focus on two issues rolled into one: the attempt to prevent short-term harm to the economy and efforts to use the pressure created by the fiscal cliff to address long-run budget concerns by locking in higher revenue and spending cuts.
Congress and President Barack Obama created the fiscal cliff and can avoid it with a law. Instead, because lawmakers see the cliff as a prod to action and disagree on which pieces to eliminate, they want to replace more than $500 billion in deficit reduction set for 2013 with several trillion dollars in deficit cuts over the next decade.
They disagree about how to reduce future deficits and how quickly to do so, and those divides have stalled negotiations. Obama wants to lean more heavily on tax increases for top earners and less on structural changes to Medicare and Medicaid benefits. House Speaker John Boehner has expressed openness to higher revenue if accompanied by an overhaul of the tax code and significant reductions in future spending on entitlement programs.
Treasuries rallied after Obama’s re-election and the post- election statements from lawmakers, on concerns about the ability of Obama and Congress to prevent tax increases and spending cuts. Because Treasuries are a haven, money tends to flow into government bonds when investors’ concern about a crisis or recession increases, driving down yields.
Treasuries then fell after Obama met with congressional leaders Nov. 16 and both sides expressed optimism about a deal.
Yields for the benchmark 10-year note touched the lowest ever in July and are about two percentage points lower than the average of the past decade. Treasuries rose again today, pushing the yield on the 10-year note down by three basis points to 1.61 percent at 10:19 a.m. in New York, according to Bloomberg Bond Trader prices.
Lawmakers, particularly Republicans, have been pushing for spending cuts and warning that the U.S. risks a fiscal meltdown if it doesn’t change course. They see a politically opportune moment to reduce future deficits because of leverage that the cliff creates.
“I appreciate money’s cheap, but I don’t think it stays there forever,” said Representative Lynn Jenkins of Kansas, who will become a member of the House Republican leadership in 2013. “We know what’s coming. There’s no surprise in what’s coming if we don’t get this fixed.”
Over the long term, projected increases in health-care costs will make the U.S. budget path unsustainable. Debt as a percentage of the economy exceeds 70 percent for the first time since 1950, according to the Congressional Budget Office.
Eventually, the U.S. would run the risk of a “sudden fiscal crisis,” the CBO said in June.
“Such a crisis would confront policymakers with extremely difficult choices,” CBO wrote. “To restore investors’ confidence, policy makers would probably need to enact spending cuts or tax increases more drastic and painful than those that would have been necessary had the adjustments come sooner.”
Obama’s budget plan, which includes higher taxes for top earners and some spending cuts, would stabilize debt as a percentage of the economy over the next decade at about 76 percent. After that, deficits would widen, according to the Office of Management and Budget.
Jenkins said overhauling entitlement programs and the tax code represents the only path to a better fiscal picture for the government.
“There is an urgency, at least in our conference, to stop the madness and to put us on a course correction,” she said. “Now, I think we are very well aware that it’s taken decades to make the mess and it’s going to take decades to clean up the mess.”
Market data suggest that the U.S. has more room to borrow money to finance investments and avoid moving too quickly toward austerity that could undermine the economic recovery.
“If this was you and me running a business, would we think this was a good idea to borrow some of this money and do stuff? I think so,” Kit Juckes, head of foreign-exchange research at Societe Generale SA in London, said in a telephone interview. “The market is saying that the disciplines we would force on a small open economy are not the same as the ones you force on the world’s No. 1 reserve currency. That’s just the way it is.”
Optimism about the U.S. economy and its future isn’t the only reason Treasury yields are historically low. Concern that Europe’s debt crisis will intensify has made the U.S. a haven and the Federal Reserve has lowered interest rates.
Rattner is on the steering committee of the Campaign to Fix the Debt, a bipartisan group advocating deficit reduction. He said markets don’t always understand the political forces shaping policy.
“It’s not like you can have a supercomputer to tell you what’s happening in Washington,” he said in an interview. “It’s very impressionistic and free form.”
Congress should try to strike a balance between avoiding short-term economic harm and enacting changes that will reduce “unsustainable” future deficits, Federal Reserve Chairman Ben S. Bernanke said Nov. 20 in a speech at the Economic Club of New York.
“Preventing a sudden and severe contraction in fiscal policy early next year will support the transition of the economy back to full employment,” he said. “A credible plan to put the federal budget on a path that will be sustainable in the long run could help keep longer-term interest rates low and boost household and business confidence, thereby supporting economic growth today.”
The Organization for Economic Cooperation and Development yesterday cut its growth forecasts and warned of the risk of a “major” global recession. U.S. gross domestic product will rise 2.2 percent this year and 2 percent next, down from predictions of 2.4 percent and 2.6 percent in May, according to the report.
The fiscal cliff would achieve significant deficit reduction. Income taxes would increase at all levels. Automatic spending cuts would take effect, half of which would come from defense spending. According to the Congressional Budget Office, $607 billion of first-year policy changes would reduce the deficit by $560 billion.
Though the effects would be spread over a year, the deficit reduction would occur too fast, Rattner said.
“The fiscal cliff is a draconian meat ax to deficit reduction, and what we need is a more graceful scalpel approach to deficit reduction,” he said.
Richard Kogan, a senior fellow at the Center on Budget and Policy Priorities in Washington, which supports deficit reduction, said it should be done in a way that avoids “starving real public needs.” The goal, he said, should be to stabilize the debt as a percentage of the economy.
“We don’t want to kneecap the economy while it’s weak,” said Kogan, a former budget official in the Obama administration.
Senator Mark Begich, an Alaska Democrat, said what investors want is a direction and some certainty about U.S. budget policy rather than a deficit-reduction target.
“No matter how you cut it, you’ve got to get a couple more trillion,” he said. “If we have a course, the financial markets will be a lot more stable.”
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