Is U.S. fiscal policy on a sustainable path: U.S. Fiscal Situation Update

Is U.S. fiscal policy on a sustainable path, the fiscal health of the United States continues to face significant challenges, with mounting debt levels and persistent budget deficits.

Amidst ongoing uncertainties regarding fiscal planning under the Trump administration, DoubleLine Capital is betting on the continued rise of long-term U.S. Treasury yields. Analysts at the investment firm believe that the current state of U.S. sovereign debt is unsustainable, with deficits likely to exceed recent projections by the Congressional Budget Office (CBO).

Current Debt Situation

DoubleLine Capital's analyst, Ryan Kimmel, expressed concerns about the sustainability of U.S. sovereign debt, highlighting that the deficits may be larger than what the CBO recently forecasted. The CBO, a nonpartisan agency, released updated predictions last week regarding the budget deficits over the next decade, indicating slight improvements compared to previous forecasts made in June 2024.

According to the CBO's latest report, the debt-to-GDP ratio—an essential indicator of a country’s fiscal health—is expected to reach 118.5% by 2035, up from approximately 98% last year. While this figure is lower than the CBO's prior estimate of 122% by 2034, concerns remain about the accuracy of these projections.

Overly Optimistic Forecasts

Kimmel argues that the CBO's forecasts are "too optimistic," particularly in light of expected tax cuts under the Trump administration. He emphasizes that these forecasts rely on moderate assumptions regarding interest rates, which could lead to significantly worsened debt dynamics if adjusted slightly.

In an interview, Kimmel noted, “If you make even minor adjustments to the interest rate assumptions, the debt dynamics will deteriorate sharply… unsustainable debt dynamics remain a concern.” The CBO's estimates are based on existing laws, assuming that the tax cuts enacted in 2017 will expire as scheduled at the end of this year.

Potential Tax Cut Extensions

If President Trump and Congressional Republicans successfully extend the current individual and small business tax rates, the CBO previously estimated that deficits could increase by over $4 trillion in the next decade. This potential extension adds further complexity to the fiscal outlook.

The CBO also forecasts that effective federal fund rates, as well as the yields on three-month Treasury bills and ten-year Treasury bonds, will remain below 4% from next year until 2035. However, Kimmel expressed skepticism about achieving this target, given that the entire yield curve is currently above 4%. He stated, “Reaching this goal could be challenging, especially if you maintain such optimistic growth expectations, which should translate into higher interest rates.” As of now, the benchmark ten-year Treasury yield is approximately 4.6%, while the federal funds rate is between 4.25% and 4.5%.

Spending Issues and Fiscal Planning

Former Treasury Secretary Scott Bessent, appointed by Trump, indicated last week that the high deficits observed in recent years stem from "spending issues." Kimmel considers this a positive sign but reiterates that the Trump administration still lacks a clear fiscal plan.

Given expectations of deteriorating fiscal prospects, Kimmel suggests that the U.S. government may need to issue more debt. In response, DoubleLine Capital is positioning itself for further increases in long-term Treasury yields. Notably, legendary investor Stanley Druckenmiller has also disclosed his bearish stance on U.S. Treasuries.
Kimmel remarked, “We believe the debt dynamics are unfavorable for the long end of the yield curve… We have already seen the curve steepen significantly, but we believe there is still room for further steepening.”

Conclusion

In summary, the fiscal landscape in the United States remains uncertain, with concerns about the sustainability of national debt and rising deficits. As DoubleLine Capital anticipates increasing long-term Treasury yields, it highlights the pressing need for a coherent fiscal strategy under the Trump administration. The interplay between tax policies, spending, and interest rates will significantly influence the future of U.S. fiscal health. Investors and policymakers alike must remain vigilant as these dynamics evolve in the coming years.

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