A Million Simulations, One Verdict for US Economy: Debt Danger Ahead

Economic

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Summary:

The Congressional Budget Office warned in its latest projections that US federal government debt is on a path from 97%...

The Congressional Budget Office warned in its latest projections that US federal government debt is on a path from 97% of GDP last year to 116% by 2034 — higher even than in World War II. The actual outlook is likely worse.

From tax revenue to defense spending and interest rates, the CBO forecasts released earlier this year are underpinned by rosy assumptions. Plug in the market's current view on interest rates, and the debt-to-GDP ratio rises to 123% in 2034. Then assume — as most in Washington do — that ex-President Donald Trump's tax cuts mainly stay in place, and the burden gets even higher.

With uncertainty about so many of the variables, Bloomberg Economics has run a million simulations to assess the fragility of the debt outlook. In 88% of the simulations, the results show the debt-to-GDP ratio is on an unsustainable path — defined as an increase over the next decade. A Million Simulations, One Verdict for US Economy: Debt Danger Ahead_1

A Million Simulations, One Verdict for US Economy: Debt Danger Ahead_1

The Biden administration says its budget, featuring a slew of tax hikes on corporations and wealthy Americans, will ensure fiscal sustainability and manageable debt-servicing costs.

"I do believe we need to reduce deficits and to stay on a fiscally sustainable path," Treasury Secretary Janet Yellen told lawmakers in February. Biden administration proposals offer "substantial deficit reduction that would continue to hold the level of interest expense at comfortable levels. But we would need to work together to try to achieve those savings," she said.

Trouble is, delivering on such a plan will require action from a Congress that's bitterly divided on partisan lines. Republicans, who control the House, want deep spending cuts to bring down the ballooning deficit, without specifying exactly what they'd slash. Democrats, who oversee the Senate, argue that spending is less of a contributor to any deterioration in debt sustainability, with interest rates and tax revenues the key factors. Neither party favors squeezing the benefits provided by major entitlement programs.

In the end, it may take a crisis — perhaps a disorderly rout in the Treasuries market triggered by sovereign US credit-rating downgrades, or a panic over the depletion of the Medicare or Social Security trust funds — to force action. That's playing with fire.

Last summer provided a foretaste, in miniature, of how a crisis might begin. Over two days in August, a Fitch Ratings downgrade of the US credit rating and an increase of long-term Treasury debt issuance focused investor attention on the risks. Benchmark 10-year yields climbed by a percentage point, hitting 5% in October — the highest level in more than one and a half decades.

As for how things might end, Britain's experience in fall 2022 provides a glimpse into the abyss. Then-Prime Minister Liz Truss's plan for unfunded tax cuts sent the gilt market into a tailspin. Yields soared so quickly that the central bank had to step in to snuff out the risk of an outright financial crisis. The bond vigilantes' actions forced the government to call off the plan and Truss out of office.

For the US, the dollar's central role in international finance and status as the dominant reserve currency lowers the odds of a similar meltdown. It would take a lot to shake investor confidence in US Treasury debt as the ultimate safe asset. If it did evaporate, though, the erosion of the dollar's standing would be a watershed moment, with the US losing not just access to cheap financing but also global power and prestige.

Variable Variables

How does the CBO, Washington's official budget watchdog, arrive at its debt forecast? The CBO's assumptions for crucial variables — GDP growth around 2%, inflation returning to 2%, interest rates drifting down from the current levels — are squarely in the ballpark of plausibility. They're also not far from numbers in the Federal Reserve Bank of Philadelphia's Survey of Professional Forecasters. Indeed, the CBO's view on rates is a little higher than the most recent consensus.

Examine them closely, though, and key assumptions underpinning the CBO forecast appear optimistic:

By law, the CBO is compelled to rely on existing legislation. That means it assumes the 2017 Trump tax cuts will expire as scheduled in 2025. But even President Joe Biden wants some of them extended. According to the Penn Wharton Budget Model, permanently extending the legislation's revenue provisions would cost about 1.2% of GDP each year starting in the late 2020s.
The CBO also must assume that discretionary spending, which is set by Congress each year, will increase with inflation, not keep pace with GDP. As a result, defense spending falls from around 3% of GDP now to about 2.5% in the mid-2030s — a tall order given the wars currently raging and the geopolitical threats that loom. Former Treasury Secretary Lawrence Summers says a more realistic forecast would add at least 1% of GDP to the CBO's outlook.
Market participants aren't buying the benign rates outlook, with forward markets pointing to borrowing costs markedly higher than the CBO assumes.

Bloomberg Economics has built a forecast model using market pricing for future interest rates and data on the maturity profile of bonds. Keeping all the CBO's other assumptions in place, that shows debt equaling 123% of GDP for 2034. Debt at that level would mean servicing costs reach close to 5.4% of GDP — more than 1.5 times as much as what the federal government spent on national defense in 2023, and comparable to the entire Social Security budget.

Heavyweights from across the political spectrum agree the long-term outlook is unsettling. Fed Chair Jerome Powell said earlier this year it was "probably time — or past time" for politicians to get going in addressing the "unsustainable" path for borrowing. Former Treasury Secretary Robert Rubin said in January the nation is in a "terrible place" with regard to deficits. From the realm of finance, Citadel founder Ken Griffin told investors in a letter to the hedge fund's investors Monday that US national debt is a "growing concern that cannot be overlooked." Days earlier, BlackRock Inc. Chief Executive Officer Larry Fink said the US public debt situation "is more urgent than I can ever remember." Ex-IMF chief economist Kenneth Rogoff says while an exact "upper limit" for debt is unknowable, there will be challenges as the level keeps going up.

Rogoff's broader point is well taken: forecasts are uncertain. To put some parameters around the uncertainty, Bloomberg Economics has run a million simulations on the CBO's baseline view — an approach economists call stochastic debt sustainability analysis. Each simulation forecasts the debt-to-GDP ratio with a different combination of GDP growth, inflation, budget deficits, and interest rates, with variations based on patterns seen in the historical data.

In the worst 5% of outcomes, the debt-to-GDP ratio ends 2034 above 139%, which means that the US would have a higher debt ratio in 2034 than crisis-prone Italy did last year.

Yellen has another way of thinking about debt sustainability: inflation-adjusted interest expense, which she's indicated she'd prefer to see below 2% of GDP. On that basis, the results are more hopeful — finding that the metric averaged over the next 10 years violates the threshold in less than a third — 30% — of simulations. The Treasury chief herself acknowledged in a Feb. 8 hearing that "in an extreme case" there could be a possibility of borrowing reaching levels that buyers wouldn't be willing to purchase everything the government sought to sell. She added that she saw no signs of that now.

Partisan Politics

Getting to a sustainable path will require action from Congress. Precedent isn't promising. Disagreements over government spending came to a head last summer, when a standoff over the debt ceiling brought the US to the brink of a default. The deal to halt the havoc suspended the debt ceiling until Jan. 1, 2025, postponing yet another clash over borrowing until after the presidential election.

It's hard to imagine a US debt crisis. The dollar remains the global reserve currency. The annual and unseemly spectacle of government-shutdown brinksmanship typically leaves barely a ripple on the Treasury market.

Still, the world is changing. China and other emerging markets are eroding the dollar's role in trade invoicing, cross-border financing and foreign exchange reserves. Foreign buyers make up a steadily shrinking share of the US Treasuries market, testing domestic buyers' appetite for ever-increasing volumes of federal debt. And while demand for those securities has lately been supported by expectations for the Fed to lower interest rates, that dynamic won't always be in play.

Herbert Stein – head of the Council of Economic Advisers in the 1970s – observed that "if something cannot go on forever, it will stop." If the US doesn't get its fiscal house in order, a future US president will have the truth of that maxim confirmed. And if confidence in the world's safe asset evaporates, everyone will suffer the consequences.

Source: Bloomberg

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Zi Cheng

Economic

While the BOJ's decision to end negative interest rates hasn't stopped the yen from weakening, some analysts are beginning to expect that the yen's weakness will in turn lead to further rate hikes by the BOJ, a scenario in which weaker yen-driven inflation will prompt the hawkish voices in the central bank to become more vocal about rate hikes. However, long-term interest rates are calm and the bond market is hardly ready for another rate hike.

The Japanese currency has softened to the upper 151 range against the dollar for the first time in about 34 years. With the BOJ expected to keep monetary policy loose while U.S. interest rates remain high, traders have been selling yen to the point that market watchers see government intervention on the table.

Yet the yield on newly issued 10-year Japanese government bonds stood at about 0.74% on Tuesday -- below the 0.795% year-to-date high reached in mid-March -- even after the end of the BOJ's negative interest rate policy.

A weaker yen contributes to inflation by pushing import prices higher. As the BOJ views its price stability target of sustained and stable 2% inflation as being within reach, currency traders speculate that if yen depreciation puts more upward pressure on prices, the central bank will see further rate hikes as unavoidable.

Looking at the actual impact of a softer currency on inflation, the yen has been around 13% weaker against the dollar than it was at this time last year. The BOJ's import price index for February, the most recent available, was up 0.2% on the year -- the first uptick, albeit a small one, in 11 months.

There is little trace of the much more dramatic swings seen in September and October 2022, when the yen had plunged more than 20% on the year and the import index soared more than 40%, driving up overall inflation.

"In 2022 and 2023, there was a double whammy of not just the weak yen, but also rising commodity prices," said Ryosuke Katagi, market economist at Mizuho Securities. Oil futures surged 85% on the year in March 2022, just after Russia's invasion of Ukraine, but are now up just 4%.

Reduced cost-push pressure from energy prices is expected to largely offset the inflationary effects stemming from the yen's current weakness.

"If the yen and resource prices remain where they are now, the price of imports will only rise around 5%," Katagi said. "It's unlikely that the BOJ will be forced to further raise rates because of inflation."

Some in the BOJ also see little reason to update its price scenario for now.

Market watchers expect the yen will need to weaken much further before additional rate hike by the BOJ become likely. Yujiro Goto of Nomura Securities predicted in a Friday report that the yen would reach a rate of 170 against the dollar when break-even inflation rates -- a measure of inflation expectations among investors -- matched the BOJ's 2% target.

At that point, "we can envision a path where the BOJ increases interest rates toward a neutral nominal interest rate of 2%," he said.

Few market watchers expect the yen reach this level. "The U.S. Federal Reserve will likely start cutting rates eventually, so it seems unlikely for the yen to weaken one-sidedly," said an executive at a Japanese bank.

Speculation of a market intervention by the Japanese government or the BOJ could help stem the currency's decline as well.

Still, expectations of further rate hikes are expected to grow as Japan starts to see a positive wage-price cycle. Japanese employers have agreed to significant pay raises in their annual spring negotiations with labor unions. Data published Monday by the BOJ also indicates a willingness among businesses to pass along rising costs to customers.

Source: Nikkei Asia

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Alex

Commodity

Chinese coal prices are likely to keep falling until the start of the peak summer season, suppressing imports of the fossil fuel and taking a toll on the country’s miners.

The country’s benchmark thermal coal price is down by around a quarter since early October as record output coincided with lackluster industrial demand and a relatively mild winter. The declines have steepened since late February, with prices dropping 11% to 825 yuan ($114) a ton over the last five weeks.

Power plants starting months-long seasonal maintenance are likely to add to the bearish sentiment, China Electricity Council said in a statement this week. That, as well as swollen inventories, will suppress trading activity, said the industry group that represents electricity generators.

The price downturn may run through the end of May, Thermal Coal Group, a local industrial news outlet, said on in its WeChat account on Tuesday. Demand from power plants typically picks up over the summer months due to higher use of air conditioners. China’s Coal Price Slump Likely To Persist Until Start Of Summer_1

China’s Coal Price Slump Likely To Persist Until Start Of Summer_1

Beijing has prioritized coal production in recent years to avoid a repeat of a power crunch in 2021, with Russia’s invasion of Ukraine the following year reinforcing the strategy. The policy has been successful in ensuring energy security, but has come at the expense of progress on decarbonization and led to a spate of fatal accidents at mines.

China’s domestic coal production rose 9% in 2022 and then by another 2.9% last year. Around 600 million tons a year of mining capacity has been added since 2021, according to the China National Coal Association.

President Xi Jinping has promised that the country’s coal use will start declining in the next five-year plan period starting in 2026. However, the drop in consumption is unlikely to be swift and demand will likely plateau, given the fossil fuel’s continuing role in meeting energy security.

The tepid demand and price slump will curb buying from overseas, industry consultant Mysteel said in a note this week. China has also reimposed a tax on coal imports this year to protect its own miners after inward shipments hit a record in 2023. Coal imports will drop by 2.2% this year, Fenwei Digital Information Technology Co., a market intelligence firm, said last month.

The price slump is impacting China’s coal sector, with industrywide profits down 37% in the first two months from a year earlier, National Bureau of Statistics data show. China Shenhua Energy Co., the country’s biggest coal producer, plans to almost halve spending on its coal unit this year and has cut its output target.

Source：Bloomberg

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Economic

Stocks

Market Recap

The "good news is bad news" mantra continued to play out in Wall Street overnight, as stronger-than-expected US job openings and factory goods orders joined the recent run in robust economic data to challenge the upcoming pace of Federal Reserve (Fed)'s policy easing. The debate of whether we will see cumulative 75 basis point rate (bp) cut or 50 bp rate cut this year runs on, although follow-up comments from Fed officials seem to suggest that it will have to take much more to sway their views for imminent policy easing.

In their overnight comments, both Fed officials, Loretta Mester and Mary Daly, maintained their view for three rate cuts as the likely scenario for 2024, somewhat aligning with the Fed Chair Jerome Powell's views that inflation will be on a "bumpy path" towards the central bank's 2% inflation goal. Market rate expectations saw a slight lean towards a June rate cut with a 62% odd (versus 57% at the start of the week), but with the US 10-year Treasury yields briefly touching its highest level since November 2023, major US indices struggled to pare back much gains for now.

Look-ahead: US services PMI

With the surprise expansion in the US manufacturing sector this week, eyes will be on whether the economic resilience will be mirrored in services activities as well. Past historical recessions in the US tend to be marked by its services activities in contractionary territory, so as long as we do not see it happen, the odds may continue to lean towards a soft-landing scenario.

However, with the "good news is bad news" narrative in place, markets will be hoping to see a softer read. Current market consensus is for US services Purchasing Managers' Index (PMI) to remain in expansion at 52.7, a slight uptick from the previous 52.6 in February. Focus will also be on the prices paid by the firms to offer some reassurances if inflation trend will continue to slow.

What to watch: Nasdaq 100 retesting upward trendline support

The Nasdaq 100 index is back to retest an upward trendline support in place, with its daily relative strength index (RSI) potentially facing a point of reckoning ahead by flirting with its key 50 level. Since November 2023, the daily RSI has managed to defend the mid-line, which keeps buyers in control of the upward trend. Should the trendline support fail to hold, the index may potentially move to retest the 17,800 level next. On the upside, the all-time high at the 18,468 level will remain as key resistance to overcome. Wall Street Wrap: "Good News Is Bad News" Kept US Indices on The Backfoot_1

Wall Street Wrap: "Good News Is Bad News" Kept US Indices on The Backfoot_1

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Samantha Luan

Economic

“You have men staying single longer…and then you have what I call a growing crisis of the young American male…they’re twice as likely to live at home than women. So one out of five young men live at home with their parents, and these aren’t young men going to college and coming home for holiday breaks, these are young, grown men choosing to live at home,” Whitney told CNBC this morning.

The outcome could have profound effects on the housing market, she said.

“I think you’re going to start to see housing prices begin a multi-year/decade decline, just due to supply/demand dynamics,” Whitney said. “So you’ve had a demand, supply imbalance: more demand, less supply. And I think that’s going to invert.” So what that means is supply will then outweigh demand, which is why she sees home prices falling for years.

Whitney’s take is based in part on demographic shifts. The bulk of housing is owned by people and households over the age of 40, she said. But household formations are the lowest they’ve been in more than a century, which translates into a demand problem, she said today.

Yet many experts have predicted that home prices will only continue to go up from here. Mortgage rates reached a two-decade high last year, and people were still buying homes—and because there simply aren’t enough homes, demand outweighs supply, keeping home prices high. Whitney, however, is calling it differently as shifts within the housing world, and apparently among young male adults, occur. It’s not clear what data she is referring to here or in the information above.

Whitney argued that lower-than-ever interest rates “ballooned inflation, and particularly housing inflation,” which has priced so many people out of the market. “If you’re single, the chances that you’re going to be able to afford a home on your own is less likely than if you’re a dual-income family,” Whitney said. Then she goes on to say that homeowners hold much more wealth than non-homeowners.

Whitney has long discussed a “silver tsunami” set to strike the housing market as baby boomers age and their homes are freed up. “You’ll see a supply-demand dynamic shift,” the founder and CEO of Whitney Advisory Group previously said, echoing her claims today.

“Normally you would think as rates go up, home prices would go down, and that hasn’t happened over the last two years,” she said. “I think home prices will normalize because as more inventory, more supply comes on the market, you’ll see a true clearing price that is lower than it is today. So I would say 20% lower than it is today.”

Home prices rose 6% in January; a lot of people think they’ll keep going up. In January, Goldman Sachs predicted home prices will rise 5% this year and 3.7% next year. In March, Capital Economics predicted home prices will rise 5% this year. This month, CoreLogic predicted they’ll increase by 3.1% this year (from February 2024 to February 2025).

Toward the end of last year, Whitney said 51% of people over the age of 50 are set to downsize to smaller homes, citing an AARP report at a conference, and it would bring more than 30 million housing units to the market. More supply, or better said, supply that outweighs demand, would trigger a drop in home prices.

However, this concept of a “silver tsunami” has been widely refuted. A recent analysis from Freddie Mac revealed that the 9 million homes set to come onto the market in the next decade as baby boomers age aren’t going to really disrupt the market. For one reason, younger generations will enter at the same time—meaning housing demand will continue to rise. “Some have warned of a ‘silver tsunami’ as aging boomers look to sell their homes, flooding the market with inventory,” the Freddie Mac report read. “But as this analysis demonstrates, the tsunami is more like a tide, bringing a gradual exit that will mostly be offset by new entrants.”

Additionally, Eric Finnigan, vice president of demographics for John Burns Research and Consulting, recently told Fortune that baby boomers aren’t going to crash the market because they’re powering it. His team found it takes about four deaths to equate to one home listed for sale (because a partner might hold onto it, or it may be passed down to children). The number of homes listed for sale due to deaths is rising, and it will continue to, but “it’s not a deluge,” Finnigan said. “It’s not a tidal wave of homes being listed for sale because of all these dying baby boomers.”

Source: CFO Daily

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FastBull Featured

Remarks of Officials

Atlanta Fed President Mary Daly said on April 2 as follows.

The economy and monetary policy are currently in good shape. Inflation is falling, though at a slow and bumpy pace. There is no urgency to cut rates as the labor market and economic growth are strong. It would be appropriate to maintain the current restrictive monetary policy.

Three rate cuts this year are a reasonable baseline projection, but there is a risk of cutting rates too soon because progress on inflation may stall. It is important to note that three rate cuts are just a forecast, not a commitment, and it is too early to take this as a pre-determined path. The timing and magnitude of rate cuts will depend on how fast inflation slows and whether economic activity deteriorates. If inflation continues to be stubborn, the number of cuts may be reduced.

Cleveland Fed President Mester delivered a speech on the same day. She acknowledged the risk of maintaining high interest rates for an extended period and thought that would cause unnecessary harm to the labor market. The bigger risk would be to begin reducing the funds rate too early, which could cause stagnation in the disinflation process.

The two officials both dampened expectations for a rate cut. Mester's remarks were more hawkish as she ruled out a rate cut at the May policy meeting.

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Alex

Forex

Indian Rupee (INR) loses momentum on Wednesday. The rise in crude oil prices to nearly a five-month high has exerted some selling pressure on the INR, as India is the world's second-biggest oil importer. The escalating geopolitical tensions in the Middle East and Russia-Ukraine might further boost crude oil prices and drag the INR lower. However, the robust Indian economic data and optimistic outlook for the Indian economy might limit the INR’s downside.

The final reading of Indian HSBC Services PMI for March will be due on Thursday. On Friday, Reserve Bank of India (RBI) Governor Shaktikanta Das will unveil the first monetary policy of the financial year 2024–25. According to a majority of analysts, the Indian central bank is likely to keep its key repo rate unchanged at 6.50% at its April meeting and maintain its stance of withdrawal of accommodation. On the US docket, the ADP Employment Change and the ISM Services PMI will be published on Wednesday. On Friday, the Nonfarm Payrolls (NFP) will be released.

Daily digest market movers: Indian Rupee seems vulnerable amid higher crude oil prices and global factors

Oil prices edge higher to their highest level in five months, propelled by concerns that rising tensions in the Middle East could crimp supply.

India’s HSBC Manufacturing PMI rose to 59.1 in March from the flash estimate of 56.9, below the market consensus of 59.2.

RBI would allow exchanges to offer forex derivative contracts involving the INR only for contracted exposure or hedging, compared to the current allowance of up to $100 million without any explicit underlying exposure. The rule will come into effect on April 5.

The RBI's MPC decided to keep the benchmark interest rate unchanged at 6.5% for the sixth straight meeting at its last meeting in February, citing inflationary concerns, and decided to remain focused on the withdrawal of accommodation.

Cleveland Fed President Loretta Mester said on Tuesday that she expects rate cuts this year but ruled out the next policy meeting in May.

San Francisco Fed President Mary Daly stated she thinks three rate cuts in 2024 seem "reasonable," but she needs more convincing evidence to confirm it. According to the CME FedWatch Tool, investors are now pricing in about a 65% odds of a rate cut by June, down from about 70% after the Fed's March meeting.

The US February JOLTS Job Openings climbed to 8.756M in February from a downwardly revised 8.748M in January, better than the market estimation.

Technical analysis: USD/INR keeps the bullish vibe in the longer term

Indian Rupee trades on a weaker note on the day. The bullish outlook of USD/INR remains unchanged since the pair has risen above a nearly four-month-old descending trend channel since last week.

In the near term, USD/INR is above the key 100-day Exponential Moving Average (EMA) on the daily timeframe. The 14-day Relative Strength Index hovers around 64.15 in the bullish territory, indicating that further upside looks favorable for the pair.

Any follow-through buying above a high of November 10, 2023, at 83.49 may extend its upswing to an all-time high of 83.70. The additional upside filter to watch is the 84.00 psychological level. In case of sustained trading below the support level near a high of March 21 at 83.20, the pair could fall back to 83.00 (round mark, the 100-day EMA), followed by a low of March 14 at 82.80.