US fiscal strain deepens as $40 trillion debt milestone raises treasury yield risks: Jefferies
US fiscal deterioration is increasingly becoming a key risk for global markets, with higher Treasury yields potentially putting pressure on equities and constraining the Federal Reserve's policy flexibility, Jefferies said in its latest research report.
The United States' fiscal situation is growing increasingly problematic, according to Jefferies, a major brokerage firm. The debt held by the federal government has crossed the $40 trillion threshold, raising concerns about the potential impact on Treasury yields. This could pose risks to equities and limit the Federal Reserve's ability to adjust monetary policy as needed.
In July, the US recorded its highest monthly fiscal deficit on record, amounting to $432 billion. The fiscal deficit for the first ten months of the year already exceeded the full-year deficit of $1.775 trillion. The annualized fiscal deficit-to-GDP ratio increased to 6.1%, from 5.7% in June.
Jefferies expects these fiscal issues to persist, putting upward pressure on long-term Treasury yields. Nominal US GDP growth has averaged 5.9% over the past 12 quarters, and the brokerage argues that sustained nominal growth above the 10-year Treasury yield is a sign that yields should move higher. Recent auctions have underscored the pressure, with the 10-year bond yield reaching 4.683% - the highest level since 2007 - and the 30-year yield climbing to 5.216% - its highest since 2001.
The situation is further exacerbated by rising government spending and decreasing receipts. Federal outlays jumped 21.7% year-on-year in July while receipts fell by 1.3%. Defense spending grew by 19.9% in the month. Meanwhile, net interest and entitlement spending accounted for 98.4% of annualized government receipts, highlighting the expanding fiscal burden.
The next significant market trigger, according to Jefferies, is the 10-year Treasury yield surpassing 5%. If this threshold is breached, it could pose a near-term risk to equities. Currently, the yield stands at around 4.69%. Treasury Secretary Scott Bessent's decision to double long-term Treasury buybacks may help mitigate the rise, but the underlying fiscal pressures remain.
Jefferies also noted that the Treasury's increasing reliance on short-term funding to support the long end of the yield curve highlights the constraints facing monetary policy. They believe the fiscal backdrop is supportive for gold, but higher-yield risks could make equity valuations more vulnerable if the 5% Treasury yield hurdle is met.
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