Investing.com — In a Thursday note to clients, Bank of America strategists tackled pressing questions on U.S. debt, including those on deficit outlook, fiscal sustainability, interest costs, and market risks from elevated US Treasury supply, among others.
In sum, BofA says the US debt stock “will likely keep growing and deficit outlook will remain elevated barring meaningful spending cuts or revenue growth.”
“Economic and market risks are rising but are manageable in our view for now. Treasuries are likely to cheapen with worsening supply/demand. The Fed is UST market backstop but unlikely to act until material economic or financial condition tightening,” strategists added.
Below are the key questions the strategists addressed.
1) How big is U.S. Treasury debt? BofA points out that the U.S. Treasury market consists of $28 trillion in marketable debt and $36 trillion in total public debt, including non-marketable intragovernmental holdings.
Debt metrics have surged, with total public debt exceeding 120% of GDP as of Q3 2024, and marketable debt around 94% of GDP.
2) What is the deficit outlook? According to BofA, Ddficits are projected to remain elevated, surpassing 6% of GDP for the foreseeable future, well above the historical average of 3%.
Key drivers include rising interest expenses—expected to climb from 3.3% of GDP in 2024 to 3.7% by 2027—and entitlement spending due to an aging population.
3) Can spending cuts fix the deficit? Addressing deficits through spending cuts alone is challenging without tackling entitlement and defense budgets, which dominate federal expenditures.
Even eliminating discretionary spending outside these categories would leave deficits above 3% of GDP due to rising interest costs.
“Moreover, it’s likely a tall order for all that spending to be eliminated. Actual cuts may be relatively modest,� strategists noted.
“A good starting point for savings from efficiency gains is the Government Accounting Office (GAO), outstanding recommendations. These changes could yield up to $200bn in savings.�
4) Is the fiscal outlook sustainable? The rising debt-to-GDP ratio, which surpassed 100% in 2024, signals long-term sustainability concerns.
However, the U.S. benefits from its status as the issuer of the global reserve currency and the safe-haven appeal of Treasuries, which mitigate immediate risks.
5) What are the economic costs of high debt levels? Elevated debt-to-GDP ratios can crowd out private investment through higher interest rates. Research suggests each percentage point increase in the debt ratio adds 1.5 to 5.2 basis points to 10-year Treasury yields.
6) What is the market’s view on debt? Markets expect Treasuries to cheapen further due to worsening supply-demand dynamics. Long-term risks are seen as underpriced.
7) Who buys U.S. Treasuries? Major buyers include foreign investors, pensions, banks, funds, and households. Demand is expected to remain stable despite fiscal concerns.
8) Are there auction concerns? Auction data shows robust demand for Treasuries, with metrics like bid-to-cover ratios and primary dealer takedown remaining stable.
9) Bond buyer strike flags? Key indicators to watch include rising auction tails, increased primary dealer takedown, and elevated market volatility.
10) Commercial bank risks of high yields? Higher yields could reduce loan demand and credit quality, while unrealized losses on securities may worsen. Fed intervention would be crucial to mitigate risks.
11) Could China weaponize Treasuries? This is unlikely according to BofA, as selling U.S. debt would hurt China’s economy by strengthening the yuan and weakening export competitiveness.
12) Will 10-year yields exceed 5%? Rates above 5% would likely require a reacceleration of inflation or significant supply-demand imbalances in the Treasury market.
13) How might Treasury issues be resolved? Solutions include stronger growth, reduced spending, or Federal Reserve interventions, but meaningful reforms remain challenging.
