America’s debt decision

06 March 2023

Levels of US public sector debt have exploded in the last 15 years. The financial crisis and the pandemic have lifted the ratio of US public debt to GDP from about 40% in 2007 to just under 100%. Fighting the financial crisis and COVID have had a similar effect on US debt levels as fighting the second world war. Whereas public spending and debt levels fell sharply after 1945, spending on health and welfare will keep debt rising over the coming years. By 2023 the Congressional Budget Office estimates that US debt will be equivalent to 118% of GDP, far above the wartime peak, and a threefold rise in 28 years.

In the US, unlike most western countries, the government cannot borrow whatever it needs to fund its commitments. Since 1917 the US government has needed Congressional approval to increase borrowing or, in the jargon, raise the debt ceiling. In the last 106 years the ceiling has been raised more than 100 times, generally without significant political opposition. Rising debt levels, and more polarised US politics, have changed that.

In the summer of 2011, the opposition of a Republican-controlled House to raising the debt ceiling forced the Obama administration to close government departments and furlough employees without pay. Panic hit financial markets, with US equities dropping by 17% in late July and early August. Consumer and business confidence dropped as S&P downgraded America’s credit rating from AAA to AA.

During Donald Trump’s presidency the government closed for almost five weeks, its longest ever shutdown, as Democrats in Congress resisted extra borrowing to fund the construction of a border wall with Mexico.

On both occasion deals were done, but not without disruption and market uncertainty. The ultimate fear for markets is of there being no agreement with the government being unable to pay interest on existing debt. A US debt default would be a major financial shock, hitting the value of US bonds and the dollar, two anchor points for global financial markets. It is the stuff of central bankers’ nightmares.

Such an outcome is a low probability event. But further battles over the debt ceiling are inevitable, with the next one likely this summer. The Bipartisan Policy Center estimates the US will reach its statutory debt limit between July and September. Unless Congress agrees to raise the ceiling, the Federal government will run out of money.

The Republican-led House is narrowly divided with a group of right-wing Republicans holding significant power, something that was seen during the torturous process to elect a new House speaker, Kevin McCarthy, earlier this year. In dealing with the debt issue Mr. McCarthy faces an acute dilemma. Raising the debt ceiling requires the agreement of Democratic-controlled Senate and the President. If Mr. McCarthy makes a deal the Republican rebels dislike, they could unseat him. If he fails to strike a deal, the US faces shutdowns, furloughing Federal workers and, just possibly, default.

A recent report from investment research firm MSCI noted that trading in credit default swaps which offer protection against a US default have risen sharply. The implied probability of a US default based on CDS pricing has, according to MSCI, roughly tripled since the start of the year, testifying to growing investor worries about the debt ceiling.

The pattern of past debt battles is that the Federal government limps on by closing departments and furloughing staff and a deal is eventually made. But US politics is more fractious than it was, and such an outcome is not guaranteed. In recent years events have had a worrying tendency not to conform to expectations. If you follow business, economics or financial markets, it’s a good reason to ensure you have decent Wi-Fi on holiday this summer.

PS: Inflation may have peaked, but private rental prices remain on an upward trajectory in the UK. Rents for people moving into a private accommodation rose by 12% last year according to real estate data provider Hometrack. Higher interest rates for buy-to-let mortgages, heavier taxation of landlords and more stringent energy efficiency regulations are causing buy-to-rent landlords to sell up, shrinking the supply of rental properties. ZOPA reports that the supply of rental property is almost 40% below the average levels for the last five years. At the same time demand for rental properties has soared with the end of lockdowns and the return to offices. The Resolution Foundation reports that more than 60% of the 4.4m people who rent privately are struggling to meet housing costs.

OUR REVIEW OF LAST WEEK’S NEWS
The UK FTSE 100 equity index ended the week up 0.9% at 7,947.

Economics

Bank of England governor Andrew Bailey signalled that current economic data does not point to further interest rate raises for the time being
Annual UK nominal wage growth hit 6.6% in February increasing cost pressures for UK businesses, according to the Bank of England
The average price of groceries rose by a record 17.2% in the year to February, the fastest annual increase since records began in 2008, according to Kantar
The UK energy regulator lowered the energy price cap by almost £1,000 on the back of a decline in wholesale gas and electricity prices; however, UK households still face an increase in energy bills as the government subsidy package is scaled back from April
UK mortgage approvals fell to a two-year low in January and Nationwide reported house prices falling by 1.1% in February
US new weekly jobless claims stayed below 200,000 for the seventh week in a row indicating a resilient US labour market
US 10-year treasury yields hit 4% last Thursday as stronger-than-expected economic data points to further interest rate rises by the US Federal Reserve
House prices in the US fell for a sixth straight month in December as the S&P CoreLogic Case-Shiller index reported a 0.5% monthly decline
The US manufacturing sector contracted for the fourth straight month in February, according to the Institute for Supply Management
Euro area annual inflation slowed to 8.5% in February but was still higher than economists’ expectations due to rising prices of services, goods and food
Annual inflation in Germany unexpectedly ticked up to 9.3% in February, driven by higher prices of food and services
China’s manufacturing sector grew at the fastest pace in more than a decade in February following the abandonment of the zero-Covid policy by Beijing

Business

Metro Bank reported better-than-expected profits for 2022, helped by higher interest rates, but warned that profits may deteriorate with slower interest rate rises
Schroders profits fell by 20% in 2022, dragged down by falling markets across all asset classes
Bridgewater Associates became the latest asset management firm to announce a round of job cuts following a tough 2022
Goldman Sachs was reported to be exploring the sale of its fintech business which posted heavy losses last year
US retailers Kohl’s, Lowe’s and Abercrombie & Fitch reported subdued sales as inflation hit consumer spending
UK online retailer Ocado posted losses in the year to November 2022 as consumers reduced spending and opted for cheaper alternatives
Property developer Persimmon reported that new home sales could fall as much as 40%, if demand does not pick up, as it downgraded its earnings outlook for 2023
The UK’s Competition and Markets Authority confirmed it would launch a probe into housing availability and costs after concerns that “builders are not delivering the homes people need at sufficient scale or speed”
Airlines Lufthansa and Qantas reported strong earnings buoyed by the sector’s resurgence as travel restrictions were eased last year

Global and political developments

The UK and the EU agreed on a new Northern Ireland protocol, the Windsor Framework, a deal aimed at cutting red tape and reducing the role of EU law and the European Court of Justice in the region
The Windsor Framework has been greeted positively by UK opposition parties and US president Joe Biden, but some Conservative MPs and unionists in Northern Ireland remain sceptical
European Commission president Ursula von der Leyen opened the doors to the UK joining the EU’s Horizon Europe research programme, following the new trade deal
Russia conducted the first large kamikaze drone and missile attacks on Ukraine since the start of its invasion
The G20 meeting of foreign ministers failed to agree on a statement criticising Russia’s invasion of Ukraine and its nuclear threats
US treasury secretary Janet Yellen visited Kyiv last Monday and pledged an additional $10bn in aid to Ukraine
The US announced a crackdown on countries and individuals helping Russia bypass sanctions
Western allies increased pressure on the UAE to stop the practice of ‘re-exporting’ critical goods to Russia, helping it avoid sanctions
Turkey’s earthquakes caused an estimated $34bn in physical damages, according to the World Bank
Ten EU countries, spearheaded by France, agreed to form a nuclear energy alliance to consider its use as a means to reach net-zero carbon emissions

And finally… a thief now faces jail for stealing almost 200,000 Cadbury Crème Eggs after breaking into a Telford industrial unit with a metal grinder – caught egg-handed

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