US Debt Warning: IMF Cites Unsustainable 7% GDP Deficit

Key Takeaway

• IMF's Gita Gopinath warns the U.S. fiscal deficit at 7% of GDP is unsustainable, with debt-to-GDP ratio projected to rise from 122% to 134% by 2029.
• U.S. government fiscal deficit surged to 8.8% of GDP in 2023, with only minor improvement expected in the near term.
• High U.S. borrowing rates could increase global borrowing costs and affect international financial stability, despite expectations of falling interest rates.

IMF Raises Alarm on US Debt

The International Monetary Fund (IMF) has voiced significant concerns regarding the United States' escalating public debt, with Deputy Chief Gita Gopinath highlighting the critical need for the federal deficit, currently at 7% of GDP, to be reduced. The U.S. fiscal deficit surged to 8.8% of GDP in 2023, a notable increase from 4.1% the previous year, attributed to a decline in income tax revenues and increased government spending. Despite a slight forecasted contraction to 6.6% in 2024, projections suggest a rebound to 7.1% by 2025, with the deficit expected to remain above 6% through 2029. This trajectory suggests a worrying rise in the U.S. government debt-to-GDP ratio, anticipated to escalate from 122% to 134% by 2029. Gopinath warned that unchecked U.S. fiscal challenges could jeopardize global economic stability, emphasizing the potential for a "crowding out" effect that could elevate borrowing costs worldwide.

Global Implications of US Borrowing

Gopinath's analysis extends to the broader implications of the U.S.'s fiscal policy on the global stage, particularly concerning interest rates and debt sustainability. While the U.S. does not face an immediate debt sustainability crisis, the heavy borrowing is contributing to higher interest rates, impacting global financial systems and international corporations. The expectation that interest rates will decrease does not alleviate concerns, as inflation targeting is anticipated to take longer. The recent performance of U.S. Treasury bonds and the spike in yields on the 2-year Treasury note, reaching 5% and signaling investor expectations of future Federal Reserve rate adjustments, underscore the market's reaction to fiscal and monetary policy shifts.

Hedge Fund Risks in Treasury Market

The IMF has also flagged significant risks associated with a small group of hedge funds exerting considerable control over the U.S. Treasury futures market. These funds have increased their short positions, leveraging the basis trade—exploiting price discrepancies between cash Treasuries and futures—to potentially destabilize the financial system. The Global Financial Stability Report highlights the systemic threats posed by these concentrated positions, particularly in the Treasury and repo markets, where the funds' reliance on borrowed money amplifies their bets and potential returns. The concentration of nearly half of all two-year Treasury futures positions in fewer than eight traders, and a similar concentration in longer maturities, raises concerns about the systemic importance of these funds and the potential for widespread instability should they face liquidity issues.

Street Views

• Gita Gopinath, IMF (Bearish on the U.S. fiscal situation):

  "The U.S. is running [a] very large deficit for a country with a strong demand, and they still have to deal with the last mile to bring inflation down... We can't have a deficit of 7% of GDP, it needs to be lower."