By Davide Barbuscia
NEW YORK (Reuters) – Higher debt payments and the possibility of a U.S. recession over the next 10 years could boost U.S. debt levels beyond recent forecasts and weigh on economic growth, an analyst at investment firm DoubleLine said.
The U.S. government has expanded deficit spending during economic downturns over the past century, but since 2016 deficits have increased despite continued economic expansion and low unemployment, said Ryan Kimmel, a macro asset allocation analyst at DoubleLine. This raises the risk of deeper debt-funded deficits in case of an economic contraction, he said.
“There’s finite demand for available capital out there to fund government debt issuance, and the only way you’re going to entice demand for government bonds is through higher rates,” Kimmel said. “Your interest expense goes up, which requires higher taxes, which then crimps economic growth, which again feeds through into further economic contraction … it’s a vicious spiral.”
The warning from DoubleLine, a bond-focused firm managing $92 billion in assets, comes amid rising concerns in the bond market over the U.S. fiscal trajectory ahead of the November presidential election, despite Democrats and Republicans vowing to reduce deficit spending.
Rating agency Fitch last year downgraded the country’s debt while Moody’s (NYSE:) lowered its outlook on the U.S. credit rating. The International Monetary Fund last month said the U.S. should curb rising debt levels. DoubleLine’s CEO Jeffrey Gundlach, often dubbed “the bond king,” said in May he anticipates an eventual restructuring of U.S. Treasuries because of the growing debt burden.
The nonpartisan Congressional Budget Office last month revised its deficit forecasts to reflect higher spending, but even the latest projections may be too optimistic, Kimmel said in a report this week.
The CBO estimated the ratio of debt to gross domestic product (GDP), a key metric of a country’s fiscal health, to climb to over 122% by 2034, up from 99% this year. It projects the average interest rate on outstanding federal debt to remain at around 3.5% for the next 10 years, which is below current Treasury yields above 4% and the Federal Reserve’s policy rate, currently 5.25%-5.5%.
In hypothetical scenarios with average interest rates of 4%, 5%, and 6% over the next 10 years, Kimmel calculated debt-to-GDP could spike to 126%, 136% and 147%, respectively, by 2034.
Neither CBO’s estimates nor Kimmel’s assume a recession over the next 10 years, which could exacerbate the debt burden.
Higher government borrowing would push investors to demand more compensation, lifting borrowing costs in various economic sectors, said Kimmel. Markets had a taste of that in October last year, when so-called bond vigilantes, investors who punish profligate governments by selling their bonds, pushed Treasury prices to 17-year lows.
One way to avoid these outcomes would be reducing fiscal deficits by trimming government spending, he said.
“While politically challenging, exercising fiscal restraint remains a viable option … A key question is, will politicians act before U.S. debt dynamics unravel into an unsustainable condition for the economy?”