Circling Deficit Hawks Shouldn’t Spook the Market – Bloomberg

This spring has been a good one for deficit-hawk watching. You don’t even need binoculars. They’re swooping in low and appear to be everywhere you look.

In late March, a group of conservative economists, including perennial Federal Reserve candidate John Taylor, warned of “fiscal and economic chaos” if nothing is done about the deficit. Last week, a group of liberal economists, including former Fed Chair Janet Yellen, added their voices, saying a debt crisis was coming that could cripple the government’s ability “to provide for its citizens and respond to recessions and emergencies.” An article in Fortune magazine warned that debt could “blow up the Trump economy.” Another one in the Washington Post argues that the rising deficit will be costly for every American, especially millennials, and that the “day of reckoning” is coming. Presumably, the hawks will soon be followed by bond yields so high they cripple the country.

But the hawks aren’t finding much to feed on. While deficits are indeed rising — this week the Congressional Budget Office said that the U.S. deficit would hit $1 trillion in 2020, two years ahead of schedule, and reach $1.5 trillion by 2028 — there is little reason for investors and others to panic. My colleague Justin Fox pointed out on Tuesday that the correlation between high deficits and the unemployment rate has been inconsistent. There is even less connection with the stock market. Despite the apocalyptic warnings, large deficits haven’t swamped the economy, and if anything it appears they have benefited investors, not the opposite. 

From Both Sides Now

Falling federal revenues and rising outlays are contributing to a growing budget deficit as a percentage of gross domestic product

Source: Congressional Budget Office

Going back to 1959, the stock market has averaged an annual return of 15.5 percent in the years in which the U.S. budget deficit has been greater than $500 billion. And there was only one down year in the high-deficit bunch, in 2011, when the stock market fell just 0.002 percent. The year with the biggest deficit, when it climbed to $1.4 trillion in 2009, was also one of the market’s best, up 23.5 percent. Years in which the deficit was $100 billion or less, the stock market returned an average of a little more than 6 percent.

But the averages hide the fact that there appears to be scant correlation between deficits and stock market returns. The mid-1970s were good years for deficits, when they were near zero, and bad years for the stock market. Deficits have been bigger recently, but so have stock market returns. And that’s also true if you look at not just the size of the deficit but the direction as well. During the past six decades, the stock market has averaged 9.5 percent in years in which the deficit is increasing and 6.4 percent in years in which it is shrinking. And the same can be said about interest rates, which were much higher in the 1970s and 1980s, when deficits were much smaller.

There are many reasons for the lack of correlation between deficits and stock market returns. First, deficits are often the result of government spending and tax cuts, both of which tend to be good for the market. Inflation, also apparently not related to deficits, often has a much larger pull on interest rates and the economy. A recent argument for why rising deficits have not dented the bond and stock market is that relative weak economies in Europe and elsewhere, continued aftershocks from the financial crisis and central bank bond buying have all kept interest rates artificially low and stock markets high. But the lack of correlation between deficits and the stock market dates back to well before the Fed even considered quantitative easing. The other argument is that it takes time for big deficits to do their damage. But those who predicted doom from rising deficits in the 1980s are still waiting. As far as markets are concerned, that hazy day of reckoning way out on the horizon is still just a mirage.

— Graphic assistance from Christopher Cannon

This column does not necessarily reflect the opinion of Bloomberg LP and its owners.

This Article Was Originally From *This Site*

Powered by WPeMatico