MNI INTERVIEW: Big Deficit Means Higher US Rates-SEC’s Ghamami
MNI (WASHINGTON) - A large U.S. fiscal deficit is manageable for now but it also means higher borrowing costs from the Federal Reserve over time as inflationary pressures never quite subside and risk resurfacing, SEC economist Samim Ghamami told MNI.
“We know that when debt-to-GDP increases, when the budget deficit increases, that will push the higher neutral interest rate higher,” Ghamami said in the latest episode of MNI’s FedSpeak Podcast. “The fiscal risk is real and you can look at the historical data and see there’s a positive correlation between r-star and the debt-to-GDP ratio and the budget deficit.”
This could mean this cycle of rate cuts could be less aggressive than markets envision, he said.
“In the medium to long term we will be in a more inflationary environment in the U.S. and most advance economies,” he said, citing pressures from deglobalization and demographics. “These are structural forces that can be viewed as a regime change in advanced economies in the last several years.”
FED SENSITIVE TO JOBS
Ghamami, an expert on Treasury market reforms who also previously worked at Treasury and the Fed Board of Governors, said the U.S. central bank appears inclined to cut interest rates again next week in order to prevent further weakness in jobs. But the path for monetary policy in 2025 remains uncertain, he added, in part because the central bank is reluctant to prematurely react to policy proposals from President-elect Donald Trump.
“I would highlight that based on what we saw last September and November, the Federal Reserve is extremely sensitive to labor market data,” he said.
After that, “the Fed might remain in wait-and-see mode. Historically, the Fed has not been proactive about what would happen to the fiscal situation in the U.S.”
LONG-RUN PROBLEM
He said the debt and deficit are major long-run concerns but they are primarily driven by expenditures on politically sensitive programs like Social Security and Medicare, not by cyclical deficit spending.
“Ten years from now I would be extremely worried about that, but maybe not in the short run. The accumulation of public debt and deficit and its trajectory doesn’t seem to be sustainable,” he said.
That could be one reason why bond markets remain sanguine about the long-term outlook, with the 10-year Treasury yield hovering around 4.2%. Trump’s pick for Treasury, Scott Bessent, could also be helping out, said Ghamami.
“The nominee for Treasury secretary seems to be a balanced-budget man so that could be a positive contributing factor to not having Treasury yields increase further in the past couple of weeks,” he said.
POSITIVE REFORMS
Ghamami is hopeful about the overall health of the Treasury market in the wake of reforms like central clearing, which he helped to spearhead at the SEC.
“If it gets implemented successfully I think that would be a major contributing factor for enhancing resilience of the Treasury market,” he said.
Another key goal for regulators should be ensuring the safety and soundness of principal trading whose role in the Treasury market has surged in recent years.
“It is important to make sure that principal trading firms have sufficient capital and liquidity buffers so they can continue to provide liquidity to the Treasury market in a safe way that wouldn’t along the way increase the risk to financial stability,” Ghamami said.