Markets warn on fiscal limits

Bond traders are increasingly treating big deficit spending as less potent and more costly, a shift that points to tighter fiscal limits in the next downturn. (cbo.gov) Jim Welsh, founder of Macro Tides, argued in recent posts that each new burst of government borrowing is producing less gross domestic product growth than in earlier cycles. Welsh has about four decades of market experience and publishes macro and technical analysis through Macro Tides. (macrotides.com) Economists call that relationship a fiscal multiplier: how much output rises when the government spends or cuts taxes. International Monetary Fund research says multiplier estimates vary widely, but studies generally find they are smaller in high-debt countries and depend heavily on the state of the economy. (imf.org) That matters in the United States because federal borrowing is already large. The Congressional Budget Office projected in January 2025 that the federal deficit would total $1.9 trillion in fiscal 2025 and that debt held by the public would rise to 118 percent of gross domestic product by 2035. (cbo.gov) The same debt arithmetic changes what markets may do in a recession. CBO said in its 2025 long-term outlook that a larger debt load makes the United States more vulnerable to higher interest rates because any increase raises debt-service costs more quickly. (cbo.gov) That is the backdrop for Welsh’s warning that the next recession may not deliver the old pattern of sharply falling Treasury yields. If investors demand more compensation to finance larger deficits, long-term yields can stay elevated even as growth weakens. (imf.org) International Monetary Fund staff made a similar point in March 2024, writing that higher real rates, weaker medium-term growth, and heavier debt loads are putting pressure on fiscal trends and financial stability. A separate 2024 IMF working paper said debt dynamics and fiscal policy interact in ways that standard models can miss. (imf.org 1) (imf.org 2) For traders, that means policy reversals can produce bigger swings than they did when inflation was low and borrowing costs were near zero. A market that doubts new spending will lift growth, but expects it to lift issuance, can reprice both stocks and bonds at the same time. (imf.org) The practical question is no longer whether fiscal policy still works at all. It is how much growth each borrowed dollar can buy when debt is already high, rates are higher than they were in the 2010s, and investors are watching the bond market for the answer. (cbo.gov)