Six months into the fiscal year and the deficit is a hair under $600 billion; one might be tempted to do some easy math and predict a headline number of over $1 trillion for the entire year. However, things get better for the budget (relatively speaking) from here. April is the most lucrative month for the Treasury, with estimated tax payments from both individuals and corporations, as well as 1040 payments from those who under-withheld in 2017. This is backstopped by second and third quarter estimated payments due in June and September. Last year, the April-September deficit was $140 billion, which means that we are on pace for a 2018 shortfall of “only” $800 billion.
Business as Usual
Much has been made of the Federal Reserve’s policy stance which promises to reverse the process of Quantitative Easing (QE) begun during the last financial crisis in 2008-09. As you may recall, the Fed attempted to lower long-term interest rates in the face of ballooning government deficits by purchasing unprecedentedly large amounts of notes and bonds in the open market. While the effect of QE on rates themselves is uncertain, the operation did result in the Federal Reserve owning a much larger than normal percentage of long-term government debt.
Now, as part of its move towards “normalized” interest rates, the Fed has promised to reduce both the percentage and the number of Treasuries that it holds. Some observers have suggested that this selling, combined with the continued large issuance required by the budget deficit, will lead to an oversupply in the market. At this point, the discussion is still hypothetical because despite all of its talk, the Fed has not begun to reduce its holdings at the long-end of the Treasury curve. In fact, the Fed has purchased $15 billion in newly-issued 30-year bonds over the last year.
Recently, the rate of increase in long-term Treasury supply has begun to slow as the 30-year bond vintage from the financial crisis reaches middle-age. While the Treasury is still selling $14 billion 30 year bonds every month, this is only replacing the bonds issued in 2008 which are moving into the less-than-20 years to maturity category. For this reason, we can easily envision a scenario where the supply of long-term bonds does not increase much even as the Treasury runs trillion dollar deficits—unless, of course, the government decides to increase the amount of 30-year issuance. This would seem more relevant to the supply than the Fed’s actions.
(These projections are based on no change in the level of 30-year issuance by the Treasury or purchases by the Federal Reserve Bank.)
This commentary’s view of the recent tax reform has been somewhat at odds with mainstream reporting. While we have been anxious to report on the effects of the legislation on actual tax receipts, adequate data is only now becoming available. Next month, we will offer a first-glance analysis of withholding trends and attempt to determine just how much the American worker has been affected by the changes.
The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for any individual. To determine which investment(s) may be appropriate for you, consult your financial advisor prior to investing. All performance referenced is historical and is no guarantee of future results.
Securities offered through LPL Financial, member FINRA/SIPC. Investment advice offered through Great Valley Advisor Group, a Registered Investment Advisor. Great Valley Advisor Group and Doylestown Wealth Management, Inc. are separate entities from LPL Financial.