Inflation fears have driven a spike in interest rates, and a fiscal crisis is inevitable even if not imminent, says a note from Piper Sandler.
Addressing the crisis would require cutting Medicaid and entitlements, retaining/adding payers to the tax base, and reducing government borrowing.
These are unpopular across the political spectrum, and the firm advises investors to assume that whatever the government does will likely be weak or irresponsible.
The United States retains extraordinary advantages like the dollar's reserve currency status, deep treasury markets, significant taxation capacity, military and geopolitical power, and the ability to stabilize markets via the Federal Reserve. Nevertheless, the possibility of a U.S. fiscal crisis is no longer considered a fringe concern by serious financial actors.
According to Piper Sandler, public debt as a share of GDP has crossed 100%, while productive workers are aging out of the workforce and entitlements are growing faster than GDP.
Analysts note that interest costs are soaring, and the next recession could send the deficit to rarely seen heights.
Policy makers' reactions to the growing burden of interest cost are another sign the U.S. is in the initial stages of a fiscal crisis. President Trump is pressuring the Fed to cut rates, but this does not address the root causes of the budget problems.
The firm does not believe that either a Democrat or a Republican government will respond effectively to a fiscal crisis. Both parties are loath to cut taxes with corresponding offsets, willing to remove millions of taxpayers from the income tax rolls, and hesitant to cut Medicare and other entitlements.
Any likely policy actions taken by either government will likely lead to a budgetary crisis and higher taxes or both. Piper Sandler believes that if interest rates rise to levels that put substantial pressure on the economy and the federal budget deficit, Congress would probably be roused to action. However, the odds that the actions taken would make the necessary painful, unpopular compromises required to meaningfully boost confidence in the financial markets are almost inconceivable.
