Looming Debt Crisis and the Fed’s Dilemma
The United States is facing a growing fiscal challenge, with government debt already at 97% of gross Domestic Product (GDP). Recent legislation, including the One Big Beautiful Bill act, has exacerbated the situation, prompting revised and increasingly concerning projections from the Congressional Budget Office (CBO).
Originally, the CBO anticipated a debt-to-GDP ratio of 117% by 2034. However, the new legislation pushed that estimate up by an additional 9.5 percentage points.Long-term analysis suggests a possibly unsustainable trajectory, with the possibility of reaching 250% of GDP by 2100 – a scenario that, while technically feasible with current low interest rates, demands a significant reduction in the fiscal gap, at least 10% of GDP. Currently, Washington is far from implementing such measures.Experts warn that delaying necessary adjustments will lead to an oversupply of government debt,ultimately jeopardizing its sustainability.
the cost of servicing this debt is rapidly escalating. The US Treasury paid $1.2 trillion in interest over the past year, a figure projected to rise to $1.4 trillion by 2026. Maintaining current interest rates is crucial to prevent further increases. Specifically, a drop in the 5-year Treasury yield below 3.1% – requiring at least a 75 basis point cut from the Federal Reserve – is needed to stabilize costs.This potential for rate cuts is being signaled by Federal Reserve Chair Jerome Powell, who is increasingly focusing on employment data. While inflation remains stubbornly above the 2% target – with the Consumer Price Index (CPI) exceeding that level for over four years and Producer Price Index (PPI) recently surging 0.9% in a single month - weakening job numbers are driving the shift in focus. Recent revisions have erased hundreds of thousands of jobs from the reported figures, raising concerns about economic slowdown.
The Fed, tasked with balancing inflation and employment, appears to be prioritizing the latter, fearing a rise in unemployment. This pivot is expected to be welcomed by the stock market, historically reacting positively to rate cuts when near record highs, with an average 12-month return of nearly 14% following such moves.
However, this potential market boost is unlikely to benefit the majority of Americans. As seen after the COVID-19 pandemic, wage growth is unlikely to keep pace with inflation, further widening the wealth gap. This pattern suggests a continuation of the current trend, where those with assets benefit while the financial burden on lower and middle-income households increases.
Disclaimer: For details purposes only. Past performance is not indicative of future results.
