U.S. Budget Concerns

The federal budget has resurfaced as a significant concern. Tax cuts and economic stimulus during Donald Trump’s presidency, coupled with substantial spending by President Joe Biden, have widened the disparity between revenue generated and funds allocated. Interest rates have risen in the past two years, making it more costly to manage additional debt. Forecasts indicate substantial spending in the years ahead. Ongoing disputes over spending matters in Washington have begun to unsettle financial markets, raising concerns about the U.S. deficit.

What is the Federal Deficit?

Figure 1 – Source: The Tax Policy Center
Figure 2 – Source: Treasury Department

What is the Problem with Federal Deficits?

Why are We Here Now?

Solutions, Fallout, and Portfolio Implications

As far as solutions to the federal deficit, the two primary avenues would be, 1) an economic boom boosting tax revenues while the government tries to curb future spending, or 2) easing gridlock in Washington. Democrats generally oppose cutting safety-net spending programs and while Republicans have largely opposed tax increases. We have already seen some fallout from the recent focus on the nation’s deficit. As mentioned, demand for U.S. treasuries has weakened, and the interest on U.S. debt has largely risen to a point where it is exacerbating the deficit issues itself. If we see a solution, it could possibly come from less future government spending, which would likely bring down expectations for economic growth. One area of focus for portfolio positioning specifically has been taking advantage of the higher yields across the fixed income landscape, which has been aided by this increase in the cost of debt for the U.S.

We are reminded interest rates are a “random walk”, and very smart economists have been very wrong about the future path of rates for a long period of time. (See Figure 3.) One factor which is likely to play out, however, is interest rate volatility will likely remain elevated for some time. We believe investors should be prepared to take advantage of this volatility.

Figure 3 – Source: CNBC “Wall Street economists have been ‘consistently wrong’ in 10-year rate forecasts, and here’s why”


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