The Financial Times Alphaville blog has an interesting post today speculating on the U.S economy and interest rates. The blog points out that Credit Suisse’s Andrew Garthwaite is over-weighting equities again, because Credit Suisse sees the stock market’s recent slump as a correction, not the beginning of a longer-term bear market. And it does not believe the U.S. economy is heading into recession.
At least for now.
The post gets interesting when it points out Credit Suisse’s thinking on U.S. fiscal policy, and when the U.S. government will be forced to pare back its massive deficit.
So, the question becomes: when will the 10-year TIPS yield rise to 2% (for at that level, on our calculation, the fiscal tightening needed to stabilise government debt-to-GDP would rise to 7% of GDP, a level that would threaten the macro outlook and would also be politically hard to deliver forcing the US debt into a vicious circle of rising rates leading to a greater loss of fiscal credibility). Our answer is simple: it happens when either US banks are overweight government securities (when they have 20% of their assets in government securities, compared with 13% currently) or there is a sharp acceleration in private sector loan growth (forcing banks to lend to the private sector, not the government).
The point is … when the base yield rises to 2%, the federal government is going to have a difficult time paying ever-rising interest rates. “We think both events are unlikely to happen until late 2012,” Credit Suisse says in the blog.
For longer-term investors in TIPS, a 2% base yield (or higher) was the norm for many years through the last decade. Right now that yield is about 0.72%, well below the norm.