US Federal Reserve Chairman Jerome Powell didn’t put anyone to sleep when he left US interest rates unchanged on Wednesday evening. However, a small breeze of surprise swept through the market when the central bank’s forecast assumed only two interest rate cuts next year, down from four cuts previously announced.
In the market, interest rates rose further, while Wall Street left behind two days of notable decline. On Friday morning, Oslo Borse fell for the second day in a row.
Despite keeping rates on hold this time, Powell opened his 12th hike at the next crossroads. Ole Andre Kinnerud, credit analyst at DNB Markets, spent a week in the US where he met politicians in Washington and financiers in New York. In a brand new analysis, he puts forward an idea of what will happen when huge US budget deficits meet a whole new world of interest rates.
-More susceptible to shocks
According to Kinnerud, the United States faces two challenges.
The first is a huge budget deficit, which means you will incur increasingly huge interest payments and deplete tax revenues. This reinforces the current level of interest rates. The combination of the two means you don’t get as much flexibility in fiscal policy, he says.
Today, 20% of US income goes to cover the country’s total interest expenses. The US owes more than $30,000 billion in debt, but the superpower’s unique status relative to the dollar means the country can still take on more debt and run deficits. Taking the Congressional Budget Office’s estimates as a basis and if interest rates remain at current levels, U.S. interest payments will reach 30% of income in 2032, according to Kijnerud, who also believes the CBO’s estimates lean on the optimistic side. .
Kenrod does not believe there is a debt crisis, but he is concerned about the consequences for the world’s largest economy. Draws parallels to the 1980s.
– If you go back to the last time the state had to spend the same amount on benefits and there was little left in the budget for other things, it had a negative impact on society. Police officers were not paid on time, and roads were not updated and maintained. The metro system was destroyed. There was more crime. “If you get a lower welfare offering combined with today’s divided society, I think it will become more tense,” he says.
-Is this how things work?
– Yes I think. Many fear a sovereign debt crisis. “I believe more that the policy that is followed will end up with a worse economic policy overall and an unstable society, which in turn makes you more vulnerable to shocks,” he adds.
He does not know what the consequences will be on the financial market.
– But there’s some tension here. The Fed may respond to this tension by lowering interest rates and trying to adjust monetary policy so that fiscal policy can work better. It all depends on inflation. If inflation is still above three percent in 2024 and 2025, it’s not a given that the Fed will be able to respond to that pressure with interest rate cuts, the credit analyst says.
High interest accrual
The market is now pricing in the possibility of another US rate hike. On Thursday, Norges Bank raised interest rates again and said they were likely to be hiked again. For interest rate managers at Alfred Berg, last year’s rise in interest rates was welcome.
“It has made the world easier for us,” says Morten Steinsland, who heads the fixed income division at Alfred Berg.
They have noticed a significant increase in investments in fixed income funds, especially those focused on the high interest market. High-interest funds invest in the debt of companies that are considered slightly riskier than those with strong balance sheets. But when the risks are higher, the return can be higher too.
According to her colleague and director Maria Granlund, high-yield Nordic bonds now give a yield of between 10 and 11 percent. Meanwhile, the default rate is 2.3 percent, well below the average of 5.6 percent.
But we see that profits will be lower, cash flow will be lower, and credit quality will be lower. It is gradually weakening, but we are amazed that companies are achieving such good results,” she says.
Steensland believes that, in absolute terms, it is the best prerequisite for good returns at high interest rates next year as well.
But if you look at the risk-adjusted basis, you shouldn’t put all your money in that basket, he says.
Maria Granlund has worked in the fixed income market for over 20 years and currently manages fixed income funds in the Nordic countries. (Photo: Ellen Hoyland)
Don’t believe in raising taxes
It has only been a few months since the United States raised the debt ceiling again after intense budget negotiations. As expected, the problem was resolved as usual before the United States defaulted on its debt. Kenrod does not believe that the United States is facing a debt crisis.
The only reason the United States is able to shut down the public sector, launch attacks on Congress, have 10-15% budget deficits, and almost entirely dictate corporate tax reforms is because of the status of the dollar. He says no other country can operate this way without being punished for it.
He does not trust the fact that the budget deficit will be solved by increasing taxes.
-If you think four years ahead, it won’t happen. I think the one thing that would create a big debate about taxes in the United States is if they felt pressured to do so. If they get a credit premium on US government debt, as has happened in Italy in the past 10 years, Washington should be thinking about a surplus, not a deficit, the credit analyst says.(conditions)Copyright Dagens Næringsliv AS and/or our suppliers. We would like you to share our cases using links that lead directly to our pages. No copying or other use of all or part of the Content may be permitted except with written permission or as permitted by law. For more terms see here.
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