US public debt is a bigger concern than you think

US fiscal dynamics are likely to produce wider deficits, higher term premiums and a weaker dollar than the CBO currently anticipates.

• The Nasdaq’s partial recovery coincided with a rebound in long-term rates, reflecting the link between stronger technology-sector capital demand and higher interest rates.
• The Fed left rates unchanged while maintaining an upbeat economic assessment, warning that inflation remains too high; Nordea still expects two further Fed hikes, while it also expects additional ECB hikes.
• Recent increases in long-term US yields have mainly reflected higher real yields, driven by public-deficit financing and data-centre investment, with little evidence so far of debt-sustainability stress.
• The CBO expects weaker growth but broadly stable deficits, yet its interest-rate assumptions appear low: if market-implied rates prevail, deficits would be 1 percentage point higher than forecast.
• Demographic trends suggest that Medicaid, Medicare and Social Security spending could be several percentage points above the CBO’s projections; combined with a recession, which typically adds at least a few percentage points to deficits, the effect on debt sustainability could be catastrophic.

Takeaway: Even without a recession or major legislative changes after the midterm elections, Nordea sees higher term premiums as highly likely and expects the dollar to weaken over the longer term, although the timing depends partly on Europe’s resolution of its own problems.