The US economic expansion is being kept afloat only by extreme fiscal stimulus and war-time deficits, an astonishing state of affairs at the top of the cycle.
As the international capital markets pull the plug on US fiscal incontinence, the Fed will again have to come to the rescue. It will have to restore negative real rates and blanket the debt markets with quantitative easing to the bitter end, or risk an economic depression. This in turn will launch the next QE bubble.
A quarter of a century later the ratio is 120 per cent and vaulting past the 1945 peak. This is partly due to two big recessions and COVID, to be sure, but mostly due to three sets of unfunded tax cuts, two unfunded 21st-century wars and no serious effort to control ballooning middle-class entitlements.
Markets have also concluded that a polarised Washington is too dysfunctional to do anything about it. Part of the bond rout can be understood as a “higher-for-longer” tantrum, as the Fed talks tough and takes putative rate cuts off the table for 2024. The deeper causes are global. “If rates continue to rise the way that they’ve been rising, eventually there’s going to be a financial accident, eventually something will break,” said JP Morgan’s David Lebovitz on Bloomberg Surveillance.