Bond buyers worldwide, awash in negative-yielding debt, are crying out for fiscal spending. A seven-minute stretch in the German bund market proves it.
On Aug. 8, just before 9 a.m. in New York, Reuters published a headline that blared “Germany mulls fiscal policy U-turn.” According to an anonymous senior government official, Germany was considering abandoning its long-held balanced budget goal and instead was looking to fund an expensive climate-protection package with new debt.
That unleashed a sell-off in bunds the likes of which hasn’t been seen in recent months. In minutes, yields “went parabolic” in a move that looked like one massive straight line upward. They shot up even faster than they did after European Central Bank President Mario Draghi gave a relatively upbeat assessment of the region’s economy after its most recent decision on July 25. Kevin Muir, a market strategist at East West Investment Management Co., said on Twitter what bond traders were thinking: “BOOM! Game on! Don’t underestimate how big this announcement is. Fiscal changes the whole equation.”
The watershed moment didn’t last. Germany’s Finance Ministry quickly dashed hopes of widespread fiscal spending, commenting publicly that no decision has been made on giving up on a balanced budget. The official who talked to Reuters warned of such resistance, saying that “the challenge now is how to shape such a fundamental shift in fiscal policy without opening the flood gates for the federal budget” because “once it is clear that new debt is no longer a taboo, everyone raises a hand and wants more money.”
To some, this commitment to fiscal restraint is commendable. It certainly provides a stark contrast to the trillion-dollar budget deficits in the U.S. But when a whopping $15.5 trillion of global debt yields less than zero, including the entire German curve, the lack of government spending could very well be doing more harm than good. Fitch Ratings, for instance, noted in a report this week that rock-bottom interest rates aren’t entirely good news for sovereign nations. While they make borrowing costs more manageable, they also speak to a gloomy outlook for the future:
“The economic conditions leading to structurally lower yields may not be as supportive of sovereign credit. Lower interest rates to some extent reflect weaker potential GDP growth stemming from slower productivity growth and demographic changes. These, along with low inflation, will adversely affect growth in government revenues and put upward pressure on age-related spending, adding to fiscal challenges.”
Simply put, negative yields are a painfully obvious sign that governments have room to take on more debt for projects like infrastructure improvements and climate-change related endeavors. They ought to seize the moment.
Infrastructure, in theory, should be one of the easiest things for Democrats and Republicans to agree upon. Yet it has become something of a punch line and a symbol of Washington’s paralysis. With the U.S. government able to borrow at a near-record low 2.15% for 30 years, it sure would seem like an opportune time to address the 47,000 structurally deficient bridges across the country. Recent examples abound of how this has become a pressing issue, including a railing collapse in Chattanooga, Tennessee, earlier this year in an area the mayor called “one of the most heavily trafficked intersections in the country.” Or perhaps the federal government could be bold and take a more active role in high-speed rail or finally make an additional train tunnel linking New Jersey to Manhattan a reality.
At least some people in Washington understand that spending more on infrastructure would be a near-surefire way to boost the country’s long-term growth potential. Jeffrey Stupak, a macroeconomic policy analyst for the Congressional Research Service, noted in a report last year that direct federal spending on nondefense infrastructure was less than 0.1% of gross domestic product in 2016 and that its relative spending lagged behind most Group of Seven countries (naturally, Germany spent even less). The White House’s Council of Economic Advisers also published a report extolling the benefits of a 10-year, $1.5 trillion program of infrastructure investment.
All else equal, increasing the economic growth potential of a country should boost inflation, which, in turn, should send bond yields higher. This is the feedback loop that bond traders have been craving and thought they might be getting when hearing about a fiscal U-turn in Germany.