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Deficit Surge Will Lead To Lower Rates, Not Higher


Deficit Surge Will Lead To Lower Rates, Not Higher

Authored by Lance Roberts via RealInvestmentAdvice.com,

Fitch’s recent downgrade of the U.S. debt rating alarmed investors as the deficit and debt steadily increased. The downgrade sent 10-year Treasury bond yields above 4%, causing concern about America’s deteriorating financial condition. The problem is that if radical steps aren’t taken to curb spending, such will cause interest rates to rise. To wit:

The U.S. borrows in its own currency and will never actually default involuntarily as long as it has a printing press. As rising rates push that financing need higher, though, the ability of the U.S. government to change the fiscal path without politically disastrous measures like cutting entitlements or by overtly printing money is becoming more limited.

If no such radical steps are taken then it almost certainly means paying more to borrow. That rising risk-free-rate will crowd out private investment and dent the value of stocks, all else being equal.” WSJ

Such certainly seems like a logical conclusion. However, the key to the statement is in the last sentence. Many “bond bears” suggest that rates must rise as deficits increase and more debt is issued. The theory is that at some point, buyers will require a higher yield to buy more debt from the U.S. Such is perfectly logical in a normally functioning bond market where the only players are the individual and institutional bond market players.

In other words, as long as “all else is equal,” rates should rise in such an environment.

However, all else is not equal in a global economy where government debt yields are controlled by Central Banks colluding with Governments to maintain economic growth, control inflation, and avoid financial crises. Such is evident in the chart below. Since 2008, Central Banks globally have been buyers of global debt.


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