THE bipartisan US Congressional super-committee, set up in August by President Obama after the debt ceiling debate to find a minimum of $1,200bn budget savings over 10 years to put the US government on a firmer financial footing, failed last week to reach agreement, resulting in automatic triggers to cuts in defence and domestic spending from 2013 (around $600bn each).
The failure to provide an alternative (and greater) savings plan is based on two factors. First, the Republicans refused to compromise on permitting tax rises. Given tighter fiscal policy has two policy options – lower spending or higher taxes – the Republican position appears unworkable. Secondly, there is a large debate over the role of government in the US. Republicans want minimal government involvement in the economy, whereas Democrats argue for more participation, such as through “entitlement programmes”, eg, healthcare, that are proving very costly.
According to some estimates, US debt to annual income is forecast to rise from the current 66% to 96% by 2021, unless savings are made. One option is to adopt the European model of tough austerity measures today which, although lowering near-term growth, provides for a better long-term growth outlook.
Barclays Capital believes US policymakers should target a total of $6trn in budget savings to secure the US’s AAA credit rating, $4trn more than the total of $2trn under discussion. As a result, the lack of agreement is disappointing at this early stage of finding cuts, particularly since it is a very small sum of the predicted $38.3trn in total US government spending over the next 10 years. In addition, only discretionary spending is being reviewed. Social security and medicare (health insurance for the elderly) payments are considered non-discretionary and are forecast to represent $17trn of cumulative government spending over the next 10 years, with annual growth rates of nearly 6%. Without entitlement reform, the fiscal profile cannot be stabilised, with the entitlements’ share of GDP rising from 10% to 15% by 2035.
What does the lack of willingness by US policymakers to address its rising government debt levels mean for investors? In the main, bond investors (buyers of US debt) should be the most impacted, although the effects could be minimal in the near term.
First, the credit rating agencies have already stated that they are unlikely to downgrade the US rating in the short term following Standard & Poors’ reduction in rating from AAA to AA+ in August.
Next, the universe of risk-free assets is declining. Recent losses from the universe include Italy and arguably France. Even though the credit worthiness of the US is certain to deteriorate over the next few years, US bond yields (cost of borrowing) may not rise as a result of a reduction in credit quality as investors seek safe havens for their monies. The US’s safe haven status should be retained because the US dollar is the reserve currency of the world and the US banking system is smaller as a proportion of its GDP relative to other leading nations (and therefore less risky).
In truth, politicians are only likely to implement tough austerity measures to regain control of public finances when they are pushed into a corner and US bond market investors appear unwilling to force the issue, at least in the short term. Over the next year, US treasury prices may be supported by the weak global macroeconomic environment rather than fall due to the vagaries of US politicians.
Darren Ruane,
Senior Bond Strategist, Investec
