The widening US budget works against the Fed
Budget positions across the US, euro area and Australia are widely dispersed despite unemployment still near its lowest level in decades.
The recent sharp increase in the already-high US budget deficit is making the Fed's job harder. The same holds true for the euro area budget and the ECB, although on a vastly less alarming scale. The Australian budget has improved slightly, helping the RBA at the margin. The US and euro area budgets could widen further if the bond market's longstanding signal of recession is realised, while the ever-present risk of a sustained correction in commodity prices is the main issue for Australia's budget.
The charts below compare budget positions and unemployment rates across the US, euro area and Australia.
The budget position is approximated by the broad national accounts measure of net lending for the total general government sector, which spans central, state and local government.
Despite similarly tight labour markets in all jurisdictions, where unemployment is still broadly at the lowest level in decades, fiscal positions are widely dispersed.
Smoothing the volatility in the data, the US is the outlier, where the budget deficit has recently widened to about 7½% of GDP, which, excluding the worst point of COVID, is the largest shortfall in just over a decade.
Australia is at the other extreme with a smoothed deficit of about 2% of GDP, which is only a little wider than the average deficits posted before the onset of COVID as infrastructure-driven state government deficits more than offset a commodity-price-boosted federal government budget that is broadly in balance (note that the federal budget in cash terms is slightly in surplus).
The euro area is in between with a smoothed deficit of about 3¾% of GDP, which is still the largest deficit in about a decade for this group of countries.
There is no unique way of measuring the contribution of a budget to an economy, but it is clear that the recent increase in the already-large smoothed US deficit is working against the Fed’s efforts to slow the economy.
The same holds true in the euro area, albeit on a vastly less alarming scale than the US, where the smoothed budget deficit has widened slightly since just before the ECB started raising rates, holding broadly steady recently.
In Australia, the budget deficit has narrowed slightly in trend terms since the RBA started raising rates last year, thanks to the windfall from high commodity prices, where company tax receipts recently reached an all-time high.
Recent IMF forecasts suggest that there will be relatively little change in budget positions over the next few years, albeit with some improvement in the euro area.
This outlook seems overly optimistic as the bond market has long signalled a high risk of recession in late 2023/H1 2024 in both the US and euro area based on the earlier inversion of yield curves at relatively high levels of interest rates.
Australia has had more success in achieving soft landings than most advanced economies, but the risk to the deficit locally lies with the ever-present possibility of a sustained correction in commodity prices, even if the RBA opts to limit the looming rise in unemployment at the cost of higher inflation.
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Based in Sydney, Kieran Davies is Chief Macro Strategist at Coolabah Capital Investments, an asset manager with 40 executives and over $8 billion in fixed-income strategies. Kieran is responsible for macroeconomic research and investment strategy, contributing to the investment decisions of the firm. Kieran has long experience as a macroeconomist in both the private and public sectors. He has worked most recently as Chief Markets Economist for National Australia Bank and was previously Chief Economist, Australia and New Zealand, for Barclays Bank and ABN Amro Bank/RBS. Kieran also worked as Principal Adviser on the macroeconomy and budget policy in the Commonwealth Treasury and Director of Forecasting.
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Based in Sydney, Kieran Davies is Chief Macro Strategist at Coolabah Capital Investments, an asset manager with 40 executives and over $8 billion in fixed-income strategies. Kieran is responsible for macroeconomic research and investment strategy,...
Based in Sydney, Kieran Davies is Chief Macro Strategist at Coolabah Capital Investments, an asset manager with 40 executives and over $8 billion in fixed-income strategies. Kieran is responsible for macroeconomic research and investment strategy,...
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