Ballooning coronavirus debt at the federal level poses “very serious” issues for investors, according to JPMorgan Chase & Co.’s asset management unit.
“We now expect deficits of roughly $3.5 trillion in fiscal 2020 and $3.0 trillion in fiscal 2021, bringing the debt to $23.3 trillion or 106.5 percent of GDP by September 30th,” David Kelly, J.P. Morgan Asset Management’s chief global strategist, said Monday in his weekly note. That’s just below the record 108 percent of gross domestic product in 1946, he wrote, “as the U.S. government faced the colossal debt racked up in fighting World War II.”
The coronavirus-induced recession — and the government relief measures battling it — are inflicting “major damage” to public finances, according to Kelly. Amid the uncertainty, he sees a “logical investment strategy” favoring real assets and stocks trading at low-earnings multiples globally.
The “probable path, in the aftermath of the pandemic, is one of somewhat higher inflation, somewhat tighter monetary policy and somewhat higher taxes,” Kelly said in his note. “Higher inflation could come first and, on its own, would tend to be a negative for cash and bonds, neutral for equities, and positive for real assets.”
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Congress is again hammering out new legislation to help Americans through the pandemic after negotiations between political parties broke down last week. While President Donald Trump over the weekend announced executive orders providing assistance for lost wages, a deferral on tax obligations, and a potential moratorium on residential evictions and foreclosures, challenges remain for U.S. lawmakers.
“The President announced executive actions on some of the contentious issues,” said Kelly. “However, for all practical purposes, the President does not have the authority to cut taxes or increase spending without the consent of Congress and the stop gap measures announced over the weekend will need to be replaced by a more comprehensive bill.”
Kelly estimates the total cost of the latest government support will probably heap between $1 trillion and $2 trillion on top of the roughly $2.4 trillion that Congress already approved for coronavirus relief. After the U.S. presidential election, he said further fiscal support could cost yet another $1 trillion to $2 trillion, as Americans will continue to struggle until a vaccine becomes widely available.
Meanwhile, concern is growing that the government’s rising debt will lead to a fiscal crisis, according to his note. “It doesn’t have to – provided that, once the pandemic is over, the federal government acts with discipline, the Federal Reserve maintains a relatively dovish stance, and inflation remains low,” said Kelly.
A brighter economic path could emerge in fiscal 2022, according to Kelly. To sustain investors’ confidence over the following decade, Kelly predicts they will need to see nominal GDP growth of about 5 percent annually, a U.S. budget deficit kept within $1 trillion a year, and interest rates on federal debt held around 2 percent. These metrics would lower the debt-to-GDP ratio to about 93 percent in fiscal 2031, he said.
“This improvement, while still not getting us anywhere close to our position of 10 months ago, might be sufficient to sustain the confidence of global investors in both U.S. government debt and the value of the dollar,” he wrote. But it won’t be easy.
A less benign scenario of 4 percent nominal GDP growth annually, budget deficits of $2 trillion a year, and 4 percent interest rates would cause debt to soar to 133.6 percent of GDP by 2031, Kelly estimated.
“It would be nice to believe that we will elect politicians with both the intelligence and the backbone to tighten fiscal policy once the pandemic has released its icy grip on the U.S. economy,” he said. “In case we don’t, it is important for investors to be prepared for the consequences of an unrestrained surge in federal debt.”