Despite a robust economy and persistent inflation, the US government is grappling with a deficit of 8.4% of GDP – a record outside of recession and war periods.
The Congressional Budget Office expects the debt-to-GDP ratio to balloon to an unsustainable 181% by 2053. The precarious fiscal path contributed to Fitch's removal of the US AAA credit rating. While the rating downgrade alone may not be a cause for immediate investor concern, the real issue lies in the necessity to finance the ever-expanding deficit. For H2 2023, the government aims to raise $1.9 trillion in new debt. With central banks contracting their balance sheets and the broad money supply shrinking, the onus falls on the private sector to absorb these new bonds, which could crowd out other assets. Currently, the US Treasury is mitigating the impact by predominantly issuing short-term debt, or T-bills. However, this tactic has its limitations. Bills, which have historically constituted only 23% of total debt, now make up around 70% of new issuance. Once this ratio reverts to historical norms, both risk assets and government bonds could face renewed pressure. Hence, we maintain a cautious stance on credit risk, as we feel the market has yet to fully account for these uncertainties. Interest rates have already priced in some of those issues in our view, and given the modest scale of coupon bond issuance, longer-term yields could even decline in the near term.