Jeffrey Cleveland, Chief Economist for Payden & Rygel, joined Keith Black, Managing Director of RIA Channel, to discuss the impact of the US fiscal situation on the real economy.
The US national debt is now 120% of GDP and is increasing by $2 trillion annually. Servicing this debt burden costs 3% of GDP. The last time debt service reached this level was in the early 1990s when bipartisan efforts successfully reduced spending which briefly resulted in budget surpluses. Cleveland believes that servicing the current debt is manageable if interest rates stay at this level or lower.
Budget deficits do not automatically lead to inflation, as the US has consistently run budget deficits at times when inflation was near the Fed’s 2% target. The inflation experienced after the fiscal and monetary stimulus response to COVID-19 is not likely to be repeated in the next year or two.
Today’s market environment of tight credit spreads and stretched valuation of tech stocks resembles that of the late 1990s. Similar to the late 1990s, spreads and valuations can remain near these levels for years as long as GDP growth continues and the economy avoids a recession. Cleveland believes that 2025 may see new highs in the equity market with continued tight credit spreads. When pressed for a downside scenario, he suggests a return to a 1990s scenario, where capital expenditures in the technology sector led to excess capacity that takes time to absorb, leading to an increased probability of recession.
Inflation and bond yields are more likely to decline during a hard landing. Cleveland states that the market is underestimating the probability of strong economic growth driven by productivity gains. Continuing the productivity gains achieved in 2024 could lead to economic growth with moderating inflation.
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