Analysis-US fiscal strain looms as key challenge for newly elected Trump
2024.11.06 09:13
By Davide Barbuscia
NEW YORK (Reuters) – Newly elected U.S. President Donald Trump will face fiscal challenges that could threaten the country’s standing in the global debt markets, hurting investor appetite for the nation’s debt securities, and pushing government borrowing costs higher.
U.S. budget deficits and government debt levels were largely projected to surge under either candidate in the Nov. 5 election, according to several estimates, although Democrat Kamala Harris was expected to add less debt than Trump.
The prospect of rising government debt levels as Trump’s odds improved in recent weeks helped send U.S. government bond yields higher, as many believe his trade and tax policies will reignite inflation and worsen the U.S. fiscal picture. On Wednesday, as results showed Trump winning the election, yields jumped higher with some citing bond vigilantes, referring to investors dumping government debt over worries about rising deficits. The benchmark rose as high as 4.479%.
“We see a Trump presidency as bearish for yields, given increased deficits and higher tariffs,” said Spencer Hakimian, CEO of macro hedge fund Tolou Capital Management.
A key hurdle for the new administration will likely be the reinstatement of the federal debt ceiling on Jan. 2, which was suspended in 2023 following protracted negotiations with Congress.
Washington regularly sets a limit on federal borrowing, which must be approved by a majority of lawmakers. Debt limit disputes in the past have pushed the country to the brink of default and dented its credit rating – a scenario that could be on the cards again in the event of a divided government. Republicans won a U.S. Senate majority, but neither party appeared to have an edge in the fight for control of the House of Representatives where Republicans currently hold a narrow majority.
Barring a quick resolution, the Treasury Department will likely need to use its cash reserves and so-called extraordinary measures – or an array of accounting maneuvers – to fund the government until the so-called X date, when it will no longer be able to pay all its bills. Some analysts estimate that could be in the second half of next year.
Naomi Fink, global strategist at Nikko Asset Management, expects bond volatility around the debt ceiling negotiations even if a default is averted.
“It is less probable that the U.S. actually defaults than that the market prices in the probability of an extreme event at some point, which could mean a volatility shock even in the absence of default,” she said, speaking before the election.
Possible ways to protect against Treasury volatility could be Treasury puts or credit default swaps, she added. One-year credit default swaps, which measure the cost of insuring exposure to a U.S. debt default, have recently risen to their highest in about one year on election and debt ceiling jitters, but fell sharply on Wednesday.
An even earlier fiscal test could come in December, as temporary funding measures adopted to avoid a government shutdown will keep government agencies funded until Dec. 20.
This could set the stage for a political battle even before the new Congress takes office, said Richard Francis, a senior director at Fitch Ratings, speaking before the election results.
“That’s another key issue we could conceivably look at,” he said. “We could look at the debate (around government funding) going on through the year, and then that will get tied up with the debt ceiling itself, so a lot of messy political fights starting after the election in mid-December, and then at the end of the year,” he said.
POLARIZATION
Credit rating agencies rank governments and companies based on their ability to repay their debt obligations. Metrics include economic conditions as well as governance standards.
Fitch downgraded the U.S. sovereign credit profile by one notch last year following political brinkmanship around the U.S. borrowing limit. Another debt ceiling crisis could negatively impact the country’s rating, said Francis.
The other two major rating agencies, Moody’s (NYSE:) and S&P Global Ratings, have highlighted similar concerns.
Moody’s, which remains the last of the three major rating agencies to maintain a top rating for the U.S. government, said in September that U.S. fiscal health is expected to worsen.
It lowered the outlook on its triple-A U.S. credit rating to “negative” from “stable” in November 2023. It typically “resolves” an outlook, meaning in case of a negative outlook it either brings it back to stable or goes ahead with a rating downgrade, within 18 to 24 months.
S&P Global Ratings affirmed its stable outlook on the government rating in March this year, but said its AA+ rating could come under pressure if deficits rise further due to “political inability” to curb spending or improve tax revenues.
“The rating’s weakest component stands out as the fiscal story, as well as challenges on the ability to garner bipartisan support for more medium-term structural fiscal reduction measures,” Lisa Schineller, managing director, sector lead, sovereign ratings at S&P said in a webinar last month.
“Inability to tackle these issues … could lead to some downside.”
DEBT BALLOON
Even without accounting for the likely extension of all or most of the tax cuts Trump signed into law when he was president in 2017, which expire at the end of next year, government debt held by the public could nearly double over the next decade from $26 trillion at the end of last year, according to forecasts of the nonpartisan Congressional Budget Office.
The extension of the 2017 tax cuts would add around $4.5 trillion to those projections, the CBO has estimated.
“The threat of more supply … is going to continue to put some pressure on the overall balance sheet of the U.S. government,” said Jonathan Duensing, head of U.S. fixed income at Amundi US. “In response to that, investors are going to demand more of a premium down the road to lend long to the U.S.,” he said.
The U.S. Treasury 10-year term premium, a measure of the compensation investors demand to hold long-term government debt securities, moved back into positive territory for the first time since July in October, as election uncertainty weighed on long-term bonds. It has since risen to its highest in one year, according to a New York Fed estimate.
PIMCO, a bond-focused U.S. asset manager said in an October report that, despite the near-term prospect of lower interest rates, it remained cautious on long-term bonds because of the risk of widening deficits and inflationary trade policies after the presidential election.
Duensing at Amundi US, who spoke before the election result, said what worried him was not so much the risk of a government default, which he sees as unlikely, but the potential for inflation to rise due to deficit spending, eroding the value of investments in Treasury securities.
“It’s less about investors getting their money back, it’s really about what is the value of those dollars going to be that you ultimately get repaid in.”
