When Will Credit Markets React?

All kinds of factors are coming together beautifully.

by Leonard Hyman and Bill Tilles:

The US, like many other countries, has a large demographic cohort (baby boomers) entering retirement. This new class of retirees, like those before them, will request and presumably receive their social security benefits. And, as this cohort ages its medical bills will likely increase, thus increasing outlays for federal programs like Medicare and Medicaid. Elementary, as Holmes might have said.

The US Congress recently approved a dramatic reduction in the corporate tax rate from 35% to 20%. The consensus view is that this and other provisions in the new tax law will reduce federal revenues and add about $1.5 trillion to future federal budget deficits over the next decade. (A budget compromise proposed shortly afterwards would add several hundred billion more to the deficit.)

Out of curiosity, we wanted to see what the Congress’s own internal forecaster was saying. The Congressional Budget Office, in a June 2017 report underscores the obvious: “boomers” social insurance benefits will lead to increasing federal deficits.

An old technician we knew had a simple response to the question whether a trend is long-term and meaningful. He would say, “Look at a long-term chart without your reading glasses. If you can still see the trend, it’s meaningful.” The trend line that describes the growing increase in federal deficits requires no visual aids to discern clearly.

The recently enacted corporate tax cut is now expected to add to an already growing deficit due to “demography.” Something on the order of 5-5.5% of GDP.  Bond rating agency Fitch, in analyzing the tax bill, stated plainly that it would exacerbate existing budget deficit trends despite proponents’ claims to the contrary.

We remain skeptical of the so-called “crowding out” thesis. Supposedly, the federal government’s relatively large and  growing need to sell debt has the potential to “crowd out” and distort normal credit channels and that leads to higher interest rates. Yet Germany and Japan, both nations with a large percentage of retiring boomers and more generous social insurance than the US, both experience far lower interest rates.

If we put on our bond analyst’s hat, from a simple credit quality perspective the US federal government’s credit quality is headed south. Tax collections will fall due to recent cuts in corporate tax rates. Over the same periods, expenditures will increase due to the demographic imperative.

As we’ve seen this week with a certain unfortunate class of financial products, things aren’t a problem — until they are. Reminding us of Buffett’s old line about not knowing who’s skinny-dipping (i.e. cutting it way too close financially) until the tide goes out.

If we had to guess, we’d say things proceed swimmingly for the bulk of this year. Corporate profits should be solid with a boost from lower taxes.

But at some point in the not-too-distant future the narrative may quickly change. We’ve all seen moves in the dollar, oil, and gold suggesting an end to inflation’s long slumber. Whether this results in a more hawkish Fed remains to be seen.

One further budgetary imbalance we expect the CBO to address next June is higher interest expense on a rapidly growing federal debt. The question for us is not if, but when will credit markets see this as a problem.

In the US Treasury market, the 10-year yield has already begun to move up over the past two months, a first move, and just the beginning. But corporate bonds have not broadly reacted to the factors coming together – but will likely do so soon. We think the third and fourth quarters of this year will be “interesting.” By Leonard Hyman and Bill Tilles.

When all is said and sold off, GE’s debt burden – much of it attributable to GE Capital – looks enormous versus the size of remaining assets and cash flow. Read… What’s the Chance of Iconic GE Going Bankrupt?

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  58 comments for “When Will Credit Markets React?

  1. Max Power says:

    You should also take into consideration that the budget framework legislation that just passed today will increase the deficit by a further $1.5 trillion, on top of the one generated by the tax cut.

    • BTilles says:

      Hi Max Power,

      The military and non-defense related increase in federal expenditures over the next two years that was just approved by Congress totals about $300 billion according to the NYTimes explainer this am. Not sure how you derive your additional $1.5 trillion figure.

      • Max Power says:

        I extrapolated the increase over 10 years, like the other total deficit figure, which is also spread out over years.

        • BTilles says:

          If we think about what could drive those numbers even higher–inflation, military adventurism, likely boosts in social spending to name a few, your ten year extrapolation could even be light.

      • Vinman says:

        I do not believe that we need to spend more on the military but I believe we just need to spend the same amount more effectively . We could get the Generals together to find out what military hardware is not needed and spend the money on what military hardware is needed ,
        We are also overextended just like Rome was and we now have over 1,000 bases in over 100 countries. The Generals could also decide which bases are not needed and redeploy the service people to the bases that are needed .

        • george mcduffee says:

          We could get the Generals together to find out what military hardware is not needed and spend the money on what military hardware is needed ,

          Agree, but need the “grunts” input also. Another problem is much of the equipment is now worn out after multiple deployments and needs replacement or rebuild.

        • I M says:

          Good luck fixing that system. The entire military (and government on the whole) contract system is a massive scam that is exploited as a matter of course. One need only spend an hour on USASpending.gov to find a one-woman/man company in their town with a few $100K in government contracts being run through a residential address tied to a shady shell LLC.


          A two-year-old company with one employee and little past performance will play a supporting role in one of the Defense Department’s most important tech acquisitions of the year.
          In late January, the Defense Department awarded a $7 million sole-source contract to Eagle Harbor Solutions LLC, an Alaska Native-owned 8(a) small disadvantaged business, to support the Pentagon’s enterprise cloud initiative. For months, the Defense Department has been laying the groundwork to bid out a contract for enterprisewide cloud computing services that could be worth billions…… In addition to Eagle Harbor Solutions, four other companies in Koniag Government Services are listed in the Federal Procurement Data System as having one employee in 2017, and one company—called Kadiak—listed an annual revenue of $1.

      • ed olsen says:

        I tried the e-mail and it didn’t send. Is Leonard Hyman that was an analyst at HC Wainwright? If so please give him my e-mail…. Thank you

        • Wolf Richter says:

          ed olsen,

          I don’t allow commenters to post email addresses in the comments. So I removed it. But I forwarded this email address to BTilles via email. So he now has it.

  2. Julian says:

    In contrast to what is asserted here, the corporate tax cuts will lead to greater Federal Government tax revenues across the board as the economy booms.

    It’s a Win-Win.

    • Michael K. says:

      I’m pretty sceptical of that. One only needs to look at the state of Kansas where such polices did not have any such effect. There the revenues only tanked, requiring additional tax increases to offset the losses.

      • BTilles says:

        Ditto for Okkahoma.

      • george mcduffee says:

        +10 (I live in Kansas, and it will require a decade if not a generation to repair the damage done to the public sphere from infrastructure to education and social programs. Brownback most likely would have been an ideal governor in 1918, but unfortunately it is 2018.

    • FDR Liberal says:


      Is this cynicism?

      Trickle down economics has never worked. The US is no longer an industrial economy requiring outside investment per se. We – if aggregate demand increased, the savings rate increased, employers quit investing abroad, implemented a VAT system that also ameliorated the effects on consumer staples so the poor aren’t unduly affected could turn this ship by increasing exports. Trump’s tax policies will do the opposite that supposedly it was intended.

    • rsii says:

      In the next 10 years robots and AI will start to replace wage earners. Then what?

    • Matt P says:

      Only in a trickle down fantasy world.

    • Max Power says:

      Maybe, maybe not. At the end of the day what’s going to matter is whether the bond market will sense that it’s been had and revolt. If so, then it’s game over. And with $1.2T in deficits annually, even relatively small increases in interest rates will have devastating effects.

    • Vinman says:


      You are correct Revenues went up during the Reagan tax cuts . Now if we could just cap the budget and let the revenues start to pay off our debts this would be a good thing .

      • george mcduffee says:

        This is the “Laffer curve” which was posited in antiquity. Econometric analysis provides little or no support for this construct in modern/current economies. https://en.wikipedia.org/wiki/Laffer_curve

        Two major problems (other than the Nixon/Ford economy was a long time ago and was systemically different than the current socioeconomy)

        (1) The Laffer projected results of a tax cut depends entirely on which side of the curve the economy is currently on. If to the left of the maximum, tax cuts will reduce, not increase governmental revenues.

        (2) The does not have a monolithic economy, but rather a number of highly interconnected economies/sectors which will be effected differently by tax policies, including tariffs. It is a “crap shoot” as to what the aggregate effect will be.

      • David Calder says:

        Reagan’s tax cut of 1981 cost the Treasury -9% and he spent the rest of his 8 years raising taxes. 1982-1983-1984- and 1987

  3. Nick Kelly says:

    ‘The non-partisan Committee for a Responsible Federal Budget calculates that the new funding deal adds $420bn with interest to the national debt over 10 years and that if it and the tax cuts are extended, the US’s annual deficit is on course to reach $2.1tn by 2027.’

    So in nine years, the ANNUAL deficit will be double the accumulated debt of the US when Reagan took office. This was the total debt (one trillion) since Independence and included debt from WWI, WWII, Korea, and Vietnam.

    One thing we know for sure, if the US was to get to that stage the US dollar would long since have lost status as ANY reserve currency, let alone the lead one.

    This wouldn’t be the first run on the US$. In 1978 US tourists around the world were asked to please pay in local currency, including in Italian lira!

    To shore up the dollar the US HAD to issue the Carter bonds denominated in Swiss francs and W.German marks.

    A familiar refrain hereabouts is: ‘US debt doesn’t matter, we’ll just pay everyone in more dollars’

    This is exactly what everyone suspected and why the bonds couldn’t be denominated in dollars (without paying a punitive and embarrassing interest rate).

    Needless to say,the US balance sheet in 1978 was in far better health than it is now.

    • BTilles says:

      Hi Nick Kelly,

      We probably agree more than we disagree on this. But we still need a denominator here. Talking about absolute debt numbers by itself is similar to talking about stock market deckines in points not percentages. So what is that on a debt to GDP basis? Intuitively an expanding economy can accomodate more debt–and vice versa.

      • Wisdom Seeker says:

        You can graph National-Debt-to-GDP at FRED, and it’s also at a record high now, even higher than the previous peak (WW2 spending).

        In 1978 the debt as a share of GDP was far, far lower, although the adverse trend at that time was also the subject of great anxiety.

        But frankly, the folks in the 1970s held themselves to a higher standard of fiscal discipline than nearly anyone does today. The prudence-fostering life experiences of living under a gold standard, surviving the 1929 crash and Great Depression, and actually paying off mortgages to truly own a house, have all been lost.

    • FDR Liberal says:

      Nick Kelley,

      Thx for posting. Until now I’ve never heard of Carter Bonds.

      I also googled it and Carter’s Bonds were indeed issued in Swiss francs and German marks.

  4. cdr says:

    1) ” Yet Germany and Japan, both nations with a large percentage of retiring boomers and more generous social insurance than the US, both experience far lower interest rates.”

    This is a big error on your part and quite common when analyzing interest rates. You forget the effect the ECB and negative rates have on German credit. In fact, German debt is negative rate for several years out, the last time I looked. Since negative rates are impossible outside of central bank central planning, your analysis should be adjusted for this. In fact, I believe the ECB started down this course when euro rates started to reflect the real economy. Japan is a virtually closed system. What happens there doesn’t matter much unless their money printing affects the carry trade.

    2) Almost any form of macro credit and rate analysis is virtually useless until the monetary environment is considered. Re the Fed: rate normalization implies an analysis that is more textbook oriented. A central planning environment is a narrative the Fed controls. The debate is ‘where are we now?’.

    • Maximus Minimus says:

      Germany has a net balanced budget on the national and regional level, so there is that. Structural deficits associated with MIC don’t exist elsewhere.

      Other than that, hazard a guess, why the Euro is rising vis-a-vis the dollar when the ECB is still busy printing?

      • Nick Kelly says:

        Germany has BIG trade surplus- biggest exporter of cars at 150 billion annual.
        You hear quite a few people on this site and others blaming the single currency for most problems. Italy would be better with lira, Greece with drachma. Then they could devalue, which would happen all by itself, whether they liked it or not. Their public sectors are very cool to this idea. They would rather be paid in euros.

        But if it was to happen and Germany went back to the D-Mark, the US dollar would become a second- tier currency overnight,

        German industry would howl but the Bundesbank has heard that song before.

    • BTilles says:

      re point 2) We agree. No Europrean bond buyer of US Treasuries would prudently own those securities without first hedging their currency risk. The currecy loss could more than offset the yield differential.

      • FDR Liberal says:


        Many insurance companies, hedge funds, and other financial intermediaries do not hedge against currency risks. With a rising 3-month Libor it is highly doubtful that investing in Treasuries and an overall dollar exchange rate trending down will be beneficial for foreign investors if hedging. Since you are investing in the dollar buy purchasing Treasuries, are you really going to further exchange your euros, or francs, or yen to buy more dollars then forward swap those same in all likelihood depreciating dollars into appreciating euros that will charge you more in interest every quarter as your hedge rolls off? Central Banks are tightening! Plus Draghi is retiring so a German will in all likelihood replace him which only increases your currency risk? No? It is a monetary union but nationalism and therefore their bias is still the gold standard.

        In short you are going to take a better currency to buy a lesser currency to get paid for your risk at a higer rate than Japan, Switzeraland or Germany but then you are going also exchange your good money to buy a worst one to hedge against the better one. Yes, your hedge works because the euro goes up so you win but the interest you’ve earned on the Treasury has been eaten up by a rising LIBOR not including the bank load.

      • cdr says:


        As I said, analysis and planning for the future is impossible without recognizing the ECB controls the narrative. All valuations there are a reflection of ECB QE, debt purchases, rate manipulation, and anything else they throw into the mix. Nothing there reflects a free market valuation. Not even close. Therefore, applying any analysis that assumes a predictable future course other than more ECB influence is nonsense.

        In other words, if the game is crooked, the results are also crooked. Assuming crooked results are somehow related to free market performance is silly.

        Eventually, the ECB scheme will self destruct and the Eurozone will suffer a financial catastrophe because of their prior year financial shenanigans. As I wrote above, the ECB went off on this journey when they discovered free market rates were far above those they were willing to pay. QE and the rest is a kick the can strategy. The business press supports them, otherwise the ECB would marginalize them as individuals, causing career hardships. Economists support them because they would be unemployable if they didn’t. Regardless, this scheme can not last forever, no matter how strongly it works today. At that point, a more free market oriented monetary analysis would be possible.

        Anything that looks ‘stable’ as a result of ECB monetary policy is nothing more than a carefully crafted charade. Providing analysis that implies normality is mystifying to me.

    • Max Power says:

      I would also add the fact that both of these countries (and really all developed countries except the US) have universal coverage health systems which operate a lot more efficiently than the US’ system (if you could even call what we have a “system”). Over the long term, high medical costs are going to be the number one threat to the US budget. While other countries also need to grapple with rising care costs, none are as remotely acute as the US’ situation.

      Unfortunately the US refuses to try and adopt any models which seem to work elsewhere in this regard, instead the politicians in charge are bent on either reinventing the wheel with untested solutions or doing nothing at all.

  5. Ed says:

    Not a lot of ammo left in the gun, if this little correction gets big enough to affect the real economy.

    Some day, Congress may have to do its job and make some hard choices. The last year has been all stupid and easy choices but still lots of self-satisfaction.

  6. raxadian says:

    Honesty I am still amazed this has not been a problem way zooner considering the “let’s ruin ourselves” economic policies the US had since at least the eighties.

  7. The bond market is permanently distorted so a drop in credit quality does not translate into higher rates, but more pressure on the currency, and bonds selling below par. If Treasuries are problematic what about corporate? QE was the backstop and the training wheels (Feds balance sheet) come off? But I think we could muddle through this if there wasn’t so much FOREIGN money in the system. The Russians helped elect Trump (Bush said so) and the Swiss gave him his stock market rally. He wants to make America great again with the kindness of strangers. This is where American exceptionalism gets a real test.

  8. Gerard Croce says:

    Half of me is very distressed by the alarming increase in public debt. The other half would accept much higher debt to pay for European style public services. The current government policies don’t encourage either position. Only people of wealth may feel optimistic that conditions will improve in this country.

    • two beers says:

      In the US, huge public debt is tolerated or even encouraged as long as the right side of the ledger is an increase for the oligarchs. The US working class has been trained to (irrationally) fear when the credit instead goes to support services and policies that benefit workers and the poor. IOW, debt for military contractors good, debt for healthcare bad.

    • BTilles says:

      Hi Gerald Croce,

      Maybe there should be a political party or movement devoted to improving the welfare of the “forgotten” fifty percent of the population. Also leads to an interesting question: are we better off as a nation when the plutocrats are cocky or looking over their shoulders?

      • Jim Graham says:

        MUCH MUCH better when they are looking over their shoulders.

        Or running as fast as they can.

    • ZeroBrain says:

      There is no need for high public debt even in a socialist system. Debt is a feature of mismanagement, proof that taxes collected are insufficient to cover services purchased. In the long term, this is always unsustainable – taxes rise or currency devalues.

    • Max Power says:

      See also my other post above. With respect to those European services… from a total cost to the economy it may actually be a lot cheaper as they are able to provide healthcare over there way more efficiently and as such don’t face what will truly be THE biggest threat to the US fiscal situation – very high and rising medical costs.

  9. Nick says:

    lol what’s a few more trillion with a “T”…………

    And the old fogies think us younger kids are dumb for investing in cryptos?

    • BTilles says:

      Re “what’ a few more trillion with a T…”: I believe we’re about to find out. Yields on 30 yr US Treasuries kept moving higher today despite the stock market’s late afternoon romp.

      Re “And the old fogeys think us younger kids are dumb for investing in cryptos.” Yes.

    • Nicholas says:

      Bitcoin is not created with debt so it is deflationary and therefore can preserve purchasing power. The tally stick lasted 700 years.

      This old foggy is investing accordingly.
      Check out the interview with the EOS founder on “Ivan on tech”

  10. Normal says:

    Wow, major error. The 1.5 trillion increase in debt is the total, mostly due to the cuts in personal income taxes. Changes in business taxes cause a $373 billion debt over 10 years.

  11. JM Keynes says:

    – Contrary to common believe the babyboom in the US started in 1935 and NOT in 1945. And that means that already in the year 2000 the first babyboomers started to retire.
    Source: Harry S. Dent.

    – And this perfectly fits with the labour participation rate that peaked in (surprise, surprise) the year ……… 2000 as well.

    (Off topic: I ticked the box “Notify me of follow-up comments by email”. But I never receive those emails. What’s going on here ??)

    • Wolf Richter says:

      “Baby boomers are the demographic cohort following the Silent Generation. There are no precise dates for when this cohort starts or ends; demographers and researchers typically use starting birth years ranging from the early-to-mid 1940s and ending birth years ranging from 1960 to 1964.”


      • JM Keynes says:

        – And that conventional wisdom is (outright) wrong. When one (like Harry S. Dent did) looks at what really occurs then one sees a very precise ending and beginning of those babybooms.

        – The babyboom in Europe and Australia lasted from 1945 up to 1962.
        -The japanese babyboom began in 1945 and peaked in 1949/1950.
        – The US babyboom started in 1935 and peaked in 1961.

        Source: Harry S. Dent.

        – Dent did some TRULY excellent work on the relationship(s) between spending and demographics. And he wrote a number of books on this topic. Search with the words “Harry Dent” on e.g. Amazon.
        – Based on this relationship between spending and demographics Dent made 4 very prescient predictions. One of them was that the japanese economy would “weaken” in the 1990s.
        – A second prediction (from 1993) was that the US (& Europe) would enter an “economic downturn” in 2008. (Remember what happened in 2008 ?) All based on “demographics”.

        • Wolf Richter says:

          There were many baby booms in history. Or else there wouldn’t be 7.5 billion people on this planet. But only one generation is called “Baby Boomers.” That’s the point.

          Each generation has a moniker. A “generation” in this sense is about 20 years. So here they are: Silent Generation, Baby Boomers, Generation X, Millennials, Generation Z….

          You can date all the different baby booms in history and around the globe, but only one generation (ca. 1945 – 1965 in the US) is called “Baby Boomers.” It’s a common and established moniker for that generation.

          Note that Dent says “baby boom” for periods that are outside of the established range for the generation called “Baby Boomers.”

  12. cdr says:

    Re the major thesis of the US government spending too much and the problems that may/will result:

    Not worried.

    I accept it’s a bad dynamic, but the problem is an old one and quite solvable if there’s a will. If the rest of the world happily ignores the ECB/Eurozone, the BOJ/Japan, the Swiss National banks and its equity portfolio, China’s massive debt with little to show for it, and miscellaneous sundry asset bubbles and more, the worriment of them towards the US is not credible.

    • cdr says:

      Also, it’s not the job of the US to manage its financial affairs in such a way that it protects the massive ginormous stupendously sized problems of much of the rest of the world. It’s not our job to protect them from themselves. To put it in blunt terms, it’s not our job to wipe their butts. If they someday have to suffer the consequences of their actions because we chose to go our own way, too bad for them.

      The US is living beyond its means and hopefully paying for it with soon to be rate normalized debt. The other major players just use central bank policy to pay their way. The credit markets ignore them. Goofy.

  13. Kye Goodwin says:

    Hyman and Tilles: “We remain skeptical of the so-called “crowding out” thesis.”

    I was glad to see that these authors are sceptical of this argument. One thing I think I’ve learned from the work of Steve Keen is that bank lending is never dependent on how much money is available to lend. It is limited only by the supply of credit worthy borrowers. That’s basically why all the quantitative easing didn’t work to increase lending. The money received in exchange for T-bills sold to the Fed just piled up in excess bank reserves, (or went to push up asset prices), but it couldn’t create the profitable non-financial firms or solid-income individuals that never would have a problem getting credit anyway.

  14. Kye Goodwin says:

    Its interesting that regimes of all political stripes in America end up running federal government deficits when they get into power. The MMT proponents I’ve been reading say that this is so because any nation with a trade deficit, as the US has, really can’t run a government surplus for long without causing a domestic recession or depression. The private sector wants to save, to gain over time. If money is constantly leaving the country through the trade deficit and we also want a “virtuous” government to run a surplus, that is, take money out of the economy and horde it, then the private sector will necessarily be losing, not gaining. Under these circumstances a government deficit is the only possible source for a private surplus. Norway and Germany can have government surpluses because they have trade surpluses. For them, a net removal of funds from the private sector is feasible without harming their economies, but for the US government deficits are unavoidable. Its funny to watch even the right- wingers run them up with much gnashing of teeth.

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