- ANZ warns that government debt levels in the US and Europe pose a risk to the global financial system.
- US fiscal policy may cause the Fed to raise rates faster than expected, while years of austerity in Europe has created political instability.
- It’s resulted in a serious policy challenge “which, if mishandled, could provide significant headwinds to growth and create broad volatility”.
Global markets are becoming increasingly vulnerable to rising levels of government debt, warns ANZ.
The analysts said a troubling shift is underway in the fiscal policies of the US and Europe which may prove difficult to unwind.
In short, government debt levels are back on the rise again.
When viewed in isolation, that’s often no cause for alarm — for example, the US budget deficit peaked at 10% of GDP in 2009 as authorities responded to the financial crisis.
It then improved steadily, hitting a low of 2.6% in 2015.
The problem is in the current political environment, “persistent austerity is proving difficult to maintain”.
And it’s happening at the same time as major central banks begin to wind back years of unprecedented monetary stimulus. Those two factors combined result in a much more complicated outlook.
As a result, “fiscal policy has the potential to be a major focus of markets going forward”, ANZ says.
The US budget deficit is now back up to 3.9% of GDP, and is forecast to rise to 5.4% by 2022 following the Trump administration’s tax cuts.
ANZ says the enactment of Trump’s fiscal policy at this stage of the cycle “has pushed growth materially above potential”. That means the US Fed may have to tighten monetary policy even faster.
And if the recent tremors in global stocks are anything to go by, markets are wary of the fallout if US bond yields rise faster than expected.
The level of overall public debt in the US is now expected to rise to 82% of GDP in 2022, up from just 35% in 2007.
For that number to be lower, GDP will have to rise, but ANZ sees “no evidence” that current levels of fiscal spending are raising potential GDP growth.
It’s a similar story in Europe, where total public debt has reached 86% of GDP. Despite that, ANZ notes that many Eurozone economies have made sacrifices to bring fiscal spending under control.
But it’s come at a cost.
“The political ramifications of this austerity are evident, most recently in Italy where the first populist government has been formed.”
In line with its mandate, Italy’s new government has proposed a budget with increased spending and more debt.
In response, European Council members warned overnight that the budget is in breach of EU spending rules. Italian bond yields spiked to a four-year high, and markets remain on edge.
And ANZ said it’s unfair to just blame Italy. Portugal, Belgium and Greece also have debt/GDP levels well above 100%.
Clearly, the current backdrop poses a serious policy challenge “which, if mishandled, could provide significant headwinds to growth and create broad volatility in financial markets”, ANZ said.
“The need for debt sustainability can’t be stressed enough,” the analysts said.
However, time is running out.
“For long run economic stability, there is little argument that governments need to take advantage of the current economic upswing to improve their fiscal position and create fiscal space.”
Right now, the opposite seems to be happening as the US tax cuts provide a short-term fiscal boost while Europe’s austerity drive gives rise to pockets of political instability.
Looking ahead, ANZ said European Parliamentary elections in May “will provide a good benchmark of how voting intentions and political preferences in Europe are changing”.
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