Un orateur coincé

The US 10-year yield flirted with 5% last week, as the market continues to digest the Fed’s warnings on the trajectory for policy rates amid a stubbornly resilient economy and massive net issuance of Treasuries. Yet, any data release – however flimsy - contradicting this hawkish narrative is still triggering some episodes of downward correction in yields, suggesting a fair degree of collective unease with the level long-term interest rates have reached. This is understandable. With the market now magnifying the impact of the policy tightening, the resilience of the real economy will be tested, which should make the Fed sensitive to the risk of engaging in “overkill”. Last week’s release of the payroll data for September was a case in point: after rising steeply as the US defied yet again gravity and created many more jobs than expected, yields retraced partly, possibly owing to the less scary elements of the release hidden behind the headlines. Indeed, wages decelerated further, to a pace which is consistent with a return to 2% inflation without having to make too heroic assumptions about productivity.

Still, the state of the US public finance is another source of fundamental concern for the bond market. In the short run, the ousting of Kevin McCarthy from the House Speakership and the lingering divisions within the Republican party may paradoxically help contain long-term yields if a shutdown cannot be averted, with its dampening impact on demand. Yet, what the current drama reflects of the difficulty to reach any bipartisan resolution on fiscal matters – or even full alignment within each party – does not bode well for the possibility to address the structural flaws of US public finances in the years ahead. There is probably no imminent danger. According to the CBO, under a no-policy scenario US federal debt would reach 118% of GDP in 2033, a level which has already become quite familiar in several European countries. Yet, such scenario is predicated on the partial expiry in 2025 of the tax cuts granted by Donald Trump, which of course is not a done deal if he returns to the White House. On the other side of the fence, we detect little focus on fiscal consolidation in Biden’s platform for now. With socialised spending rising on trend in the US, hard choices will be needed, and political polarisation will not help.