The ballooning federal budget deficit under President Donald Trump will force the U.S. to borrow more than $1 trillion this year and risks worsening the frenzy behind the global sell-off in stock markets.
The budget deal Senate leaders reached late Wednesday would add nearly $300 billion in government spending over two years and push the deficit higher. Even beforehand, Bank of America Corp. senior U.S. economist Joseph Song warned in a report that the federal deficit was on track to exceed 5 percent of gross domestic product by 2019, by far the largest for the economy while at full employment since World War II.
That is “exactly the opposite of what the economic textbooks say lawmakers should be doing,” said Mark Zandi, chief economist of Moody’s Analytics Inc. said in an email. “Deficit financed tax cuts and spending increases in a full-employment economy will result in more Fed tightening and higher interest rates.”
Investors remained on edge Thursday as the resurgent threat of inflation and higher bond yields renewed concerns that rising interest rates will drag on the economy. U.S. stocks dropped for the fourth time in five days, with the benchmark S&P 500 down about 1.62 percent at 1:25 p.m. New York time.
“An increase in debt instruments, people dumping bonds and concerns about higher inflation -- that is a toxic combination,” said Alexis Crow, head of PricewaterhouseCoopers LLP’s geopolitical investing group in New York. “Since the crisis, debt has not disappeared. It’s an unsustainable situation.”
In the short term, the combination of tax cuts and more government spending will throw fuel onto the economy, boosting growth, employment and probably wages. Zandi estimates the spending deal alone, if passed by Congress and signed by Trump, could add as much as 0.4 percent to economic growth this year and 0.2 percent next year, raising his growth forecast to 3.1 percent in 2018 and 2.3 percent in 2019.
But investors in Treasuries, which pay fixed payments over the life of the security, are wary of inflation, which erodes the value of their income. The 10-year Treasury yield, the key benchmark for global rates including many U.S. mortgages, reached 2.88 percent this week - its highest since January 2014 and up from 2.41 percent at the end of last year. The 30-year bond yield is now above 3 percent.
The tax cuts and spending increases are kicking in as the deficit already was rising as the retirement of Baby Boomers adds to Social Security and Medicare costs and the Federal Reserve’s rate increases raise the cost of interest payments on the U.S. debt.
Treasury Secretary Steven Mnuchin last week announced that the U.S. this year will boost note and bond sales for the first time since the global financial crisis as he seeks to finance rising budget deficits, fueled in part by the tax overhaul that Trump signed into law at the end of last year. The Fed is also rolling off its Treasury holdings.
While there is nothing Mnuchin can really do to calm the stock market, his increase in debt sales in part to finance fiscal initiatives is part of the problem, said Edward Yardeni, president of Yardeni Research Inc. in New York, who coined the term “bond vigilantes” in the 1980s to describe investors who sell bonds to protest monetary or fiscal policies they consider inflationary. Fear of the effects of more than $1 trillion in added Treasury debt this year has been part of the force behind rising yields.