Escalating US fiscal risks

Over the last week, two fantastical events caught my eye.  The first was the head of the Congressional Budget Office in the US warning of the ‘unprecedented’ exploding US public debt path, with the potential for a sharp market reaction.  The second was advance publicity for a book by former UK PM and policy arsonist Liz Truss, blaming the deep state for her rapid (self-inflicted) political demise. 

The two events are linked, with many wondering whether the US is running towards a major fiscal risk event.  The likelihood of a ‘Truss shock’ in the US is one of the questions I get asked most frequently in client discussions. The short answer, as discussed briefly in these notes before, is that the risks are growing but we are not there yet. 

To think about this, it is useful to distinguish between the fiscal numbers and the surrounding institutions.  In the UK context, the market reaction to the Truss/Kwarteng mini-budget was not simply due to the impacts of the announced policies on the UK fiscal outlook – bad those these were – but the surrounding institutional chaos. 

In the period before the mini-budget in October 2022, the Permanent Secretary to the Treasury was sacked, jibes were made about ‘Treasury orthodoxy’, OBR guidance on the consequences of the tax cuts was ruled out, and statements were made that more of this type of policy was to come.

Investors were spooked at the removal of institutional safeguards on policy decision-making, which opened up significant downside risk.  UK gilts and the currency sold off heavily after the budget announcements, followed by the government’s poll numbers as UK borrowing costs spiked up.  Even after these policies were reversed and emergency measures implemented, there were lingering costs (a ‘moron risk premium’ as it was famously called).

UK public debt levels were high and rising before PM Truss took office, and markets had remained calm.  Indeed, the UK was not alone in having high public debt levels.  The market reaction was in response to UK-specific institutional and political dysfunction.  It was concern about institutions, not just the fiscal numbers, that was the catalyst for the shock.

The full note is available at: https://davidskilling.substack.com/p/escalating-us-fiscal-risks