Long-Term U.S. Bond Yields and Little Primary Budget Deficit Progress

Figure 1: Primary Deficit Projections (% of GDP) 

Source: IMF April Fiscal Monitor

U.S. 2020’s Structural Budget Deficit 

The U.S. is making no real attempts to reduce the structural budget deficit build up over the COVID period, with the primary deficit projected to remain close to 4% into the late 2020’s (Figure 1) and well above the 2010’s. This contrasts with most DM countries, with the EZ projected to swing back to a zero primary position by 2028, as 2022 energy support measures are reversed with the decline in gas prices and government expenditure growth is projected to be restrained in Europe (Italy is planning a growing primary surplus).

In contrast, the U.S. has the structural cost of the Biden administration climate support measures (IRA act) and a deadlocked political system that makes major tax or expenditure changes unlikely before the November 2024 election. Indeed, the U.S. fiscal stance will likely not change, if Biden is reelected as president as the Republicans will likely retain the House and could gain the Senate. The scenario of a victory for president Trump, plus Republicans control of the House/Senate could led to lower government spending to GDP but to finance more tax cuts. The U.S. political system produces a reluctance to raise revenue that is projected at 31.9% in 2023 versus an average of 36.6% of GDP for advanced countries based on IMF data.

Perhaps a crisis in the U.S. government bond market could trigger a shift in stance and here the next major test is to raise the debt ceiling after the November 2024 election. In the meantime, the U.S. primary budget deficit will likely mean that the U.S. pays a higher real interest rates than during the 2010’s.This is compounded by the ongoing QT operation from the Fed, which will likely be maintain when the Fed turn towards easing in 2024. Fed Powell has indicated that this could be the case, while U.S. administration and Fed officials appear to view QT as being benign. Some merit exists to the argument that QT has not signaling effect for monetary policy in contrast to QE, but QT still has a cash flow effect on U.S. financial markets. With up to $720bln of U.S. Treasury roll offs per annum, this adds to the impact of persistent U.S. budget deficits in the coming years. In contrast, though the ECB is undertaking APP QT, the EZ is reducing the primary and overall budget deficit. Japan is certainly making slow progress on its primary budget deficit (Figure 1), but the BOJ is still undertaking QE and we feel is unlikely to abandon QE never mind swing all the way to QT.

We do see 10yr U.S. Treasury yields declining in 2024 helped by falling 2yr yields on Fed delivering 75bps of rate cuts, but we remain above consensus in our yield forecasts due to the concerns over the scale of the financing needs for the U.S. budget deficit and QT. We forecast 3.90% for end 2024, in contrast to the market median of 3.57%.