“The 2024 deficit will account for 7% of gross domestic product while the 2034 deficit will account for 6.9% of GDP,” wrote the non-partisan Congressional Budget Office (CBO) in its latest report. That makes it easy. 7% compounded for a decade roughly doubles your money. The CBO now forecasts this year’s deficit at $2trln, a revision from its $1.5trln February estimate. A new $95bln in aid for Ukraine, Israel and the Indo-Pacific region played a part. Over the coming decade, the legislation authorizing that aid will add $900bln in new spending, which of course will be funded with debt, that in turn will compound (the CBO expects at a 3.2% rate). But the US is not alone. The European Central Bank said pressure on public finances across Eurozone countries required to cope with the demands of ageing populations, climate change, and higher defense spending between now and 2070 will require nations to tighten fiscally by 3% of GDP on average. To reduce debt to the EU limit of 60% of GDP by 2070 will require nations to tighten an additional 2%. Makes it simple. 3% plus 2% equals 5% of annual fiscal tightening. “These developments will be challenging enough in isolation, and countries will face all of them simultaneously,” admitted the ECB.

“Consequently, action needs to be taken today – especially in high-debt countries facing elevated interest rates and the associated risks.” There is literally no way Europe will make such cuts in the absence of an existential crisis. Were they to, it would almost surely cause an immediate depression and a break-up of the EU. But still, policy makers for some odd reason feel obligated to make such statements. And on cue, Italy’s parliament approved a law paving the way for the devolution of fiscal powers to regional governments. You see, as we approach the endgame in a multi-decade debt super cycle, all sorts of self-serving strategies will come into view, as various nations, regions, states and cities fight for survival.

Week-in-Review: Mon: Fed’s Kashkari suggests waiting for more data before cutting / Harker says 1 cut appropriate for ’24, polls show Le Pen’s RN party having large lead in French snap elections / she says her party would cooperate with Macron if her party wins, ECB’s Lane says should not pause rate cuts baring any significant EUR devaluation / Vujcic said infl must improv for a cut in Sept, China premier Li says relations are on the right track with Australia after weekend visit, Israel began 11h ‘tactical pause’ in southern Gaza to increase the flow of aid, PBOC holds 1y MLF rate steady as exp, China IP 5.6% (6.2%e) / Ret sales 3.7% (3.0%e), US Emp mfg -6 (-10e), S&P +0.8%; Tue: RBA unch as expected but unequivocally hawkish, Hungary CB cuts 25bp as exp and reiterates hawkish guidance, Ueda says possible to hike in July depending on data, Lula criticized CB on CNN, NVDA becomes largest company in the world, Fed’s Williams says US economy moving in right direction but declines to say when he would favor a cut / Collins warns against reacting to 1-2 months of promising data, S. Korea fired warning shots as N. Korean troops briefly crossed the border, Germany ZEW 47.5 (50e), EU ZEW 51.3 (47p), EU CPI 2.6% as exp / Core 2.9% as exp, US ret sales control 0.4% MoM (0.5%e), US IP 0.9% MoM (0.3%e), S&P +0.3%; Wed: US Holiday = light volumes, PBOC Gov Pan looking to add open market bond buying and selling to its monetary policy tool kit, BCB holds rates unch unanimously, BOJ mins skew hawkish, Chile CB cuts 25bp as exp, Japanese Norinchukin bank to sell $63b worth of US and EU debt to stem losses from low yielding bond holdings, UK CPI 2.0% as exp / Core 3.5% as exp / RPI 3.0% (3.1%e), S. Africa CPI 5.2% as exp / Core 4.6% (4.5%e), US NAHB housing mkt index 43 (46e), S&P closed; Thu: Putin / Kim Jong Un form pact to provide military assistance in case of an attack, SNB cuts 25bp (50% expected), BOE unch as exp although dovish rhetoric, Indonesia CB unch – market had come to expect a hike amid material ccy weakness this month, PBOC sets currency weakest since Nov, Norges bank unch as exp, Yellen says Trump’s tariffs would increase costs for consumers, Sheinbaum’s cabinet announcement viewed as mkt friendly, China 1y & 5y LPR unch as exp, New Zealand 1Q GDP 0.3% (0.2%e), Germany PPI -2.2% (-2%e), Mexico Ret sales 3.2% (1.0%e), US Initial claims 238k (235k e), US Housing starts 1277k (1370k e), EU Cons conf -14.0 (-13.8e), S&P -0.3%; Fri: largest US equity option expiry ever, FT reports German expts to China fell sharply as trade tensions escalate, Le Pen’s NR increased its lead in latest polls, Ukraine attacks 4 refineries in southern Russia, UK cons conf -14 (-16e), Japan CPI 2.8% (2.9%e) / Core 2.1% (2.2%e), UK ret sales (core) 1.2% (-0.7%e), EU flash PMIs mfg 45.6 (47.9e) / serv 52.6 (53.4e) / comp 50.8 (52.5e), UK flash PMIs mfg 51.4 (51.1e) / serv 51.2 (53e) / comp 51.7 (53e), Mexico eco activity 5.42% (3.53%e), US flash PMIs mfg 51.7 (51e) / serv 55.1 (54e) / comp 54.6 (53.5e), US leading index -0.5% (-0.3%e), S&P -0.2%.

Weekly Close: S&P 500 +0.6% and VIX +0.54 at +13.20. Nikkei -0.6%, Shanghai -1.1%, Euro Stoxx +0.8%, Bovespa +1.4%, MSCI World +0.8%, and MSCI Emerging +1.8%. USD rose +4.5% vs Bitcoin, +1.5% vs Yen, +1.0% vs Brazil, +0.8% vs Chile, +0.3% vs Sterling, +0.3% vs Indonesia, +0.2% vs Turkey, +0.1% vs Euro, and +0.1% vs China. USD fell -4.1% vs Russia, -2.3% vs South Africa, -1.9% vs Mexico, -0.4% vs Ethereum, -0.4% vs Australia, -0.3% vs Canada, -0.1% vs Sweden, and flat vs India. Gold -0.8%, Silver +0.5%, Oil +3.4%, Copper -1.0%, Iron Ore -1.3%, Corn -3.6%. 10yr Inflations Breakevens (EU flat at 2.02%, US +5bps at 2.23%, JP flat at 1.53%, and UK -5bps at 3.60%). 2yr Notes +3bps at 4.73% and 10yr Notes +3bps at 4.26%.

2024 Year-to-Date Close: Argentina +51.4% priced in US dollars (+69.6% priced in pesos), Venezuela +29.9% priced in US dollars (+32.2% priced in bolivar), Turkey +29.8% priced in dollars (+44.2% in lira), Taiwan +22.5% (+29.7%), Denmark +21.2% (+25.5%), NASDAQ +17.8% in dollars, S&P 500 +14.6% in dollars, Netherlands +13.6% (+17.6%), MSCI World +11.1% in dollars, Hungary +8.2% (+16.1%), India +7.8% (+8.1%), Poland +6.9% (+10.1%), Malaysia +6.5% (+9.3%), Greece +6.4% (+10.1%), Colombia +6.3% (+14.2%), Italy +6.1% (+9.7%), HK +5.8% (+5.8%), Spain +5.5% (+9.2%), UK +5.5% (+6.5%), Norway +5.1% (+9.8%), South Africa +5.1% (+3.4%), Euro Stoxx 50 +4.9% (+8.5%), Germany +4.8% (+8.4%), Ireland +3.9% (+7.5%), Czech Republic +3.5% (+8.3%), Russia +3.4% (+0.8%), Sweden +2.8% (+7.4%), Japan +1.9% (+15.3%), Belgium +1.5% (+5%), Switzerland +1.2% (+7.9%), Austria +1% (+4.6%), Australia -0.2% (+2.7%), Russell -0.2% in dollars, Singapore -0.7% (+2%), Canada -0.9% (+2.8%), Israel -1.1% (+2.7%), China -1.4% (+0.8%), Chile -1.9% (+4.7%), France -2.3% (+1.1%), Korea -2.8% (+4.9%), Finland -3.2% (0%), Saudi Arabia -4% (-3.9%), New Zealand -4.3% (-0.7%), UAE -5.9% (-5.9%), Portugal -7% (-3.8%), Philippines -10.2% (-4.5%), Indonesia -11.5% (-5.4%), Thailand -14.1% (-7.7%), Mexico -14.3% (-8%), Brazil -19.3% (-9.6%).

Delphi: “There are many ways to observe time,” said the Oracle, seated on a hot rock, serene. “Most of us think in terms of linear time, but it is just one way.” I had traveled far to check in, sensing change on the horizon, but unsure as always. “There is also election-time,” said the Oracle, and seeing that I was unsure, he continued. “In your nation, November is the number 0 in election-time. October is -1, September is -2. December is +1, January +2. And so on, so forth.” I nodded, simple enough. “The economy behaves in unique ways when viewed in this way.”

Delphi II: “Plug economic variables into election-time and you will find interesting patterns emerge,” said the Oracle, his gaze unfocused, taking in the infinite horizon. “You often begin to see signs of behavioral changes in -4 and -3 when viewing election-time,” he said, referring to July and August heading into our Presidential election. “The more consequential the policy differences between candidates, and the tighter the race, the greater the impact.” I nodded. “Uncertainty in the outcome leads to delayed decision-making, reduced capital formation.”

Delphi III: “Economists have shown that uncertainty is a cancer on growth,” said the Oracle. “And it always reaches a cyclical high exactly at election-time 0.” I nodded. “As that happens, credit spreads widen considerably, P/E ratios decline, equities drop,” he said. All else equal, this made sense, although I’d not studied the election effects with precision. The Oracle apparently had or had sight into such things. “In election-time, at +1 and +2 uncertainty declines, credit spreads too. Equities bounce. And uncertainty works lower through +14 to +17 in election-time.”

Delphi IV: “The election-time effects in this November contest are without question the biggest in our lifetime,” said the Oracle, his eyes rolling back, gently closing. “Tax policy, energy policy, immigration policy, these look wildly different depending on the election outcome. And the regulatory uncertainty that has featured so prominently for business could stay as is or change radically.” Being an entrepreneur/investor in crypto during the past four years, I nodded. “Biden has proposed a 49% personal tax, a 28% corporate tax, and is still running a 7% deficit.”

Delphi V: The Oracle sat there in perfect silence, which started getting awkward. And to break the spell, I asked who would win in November. “Surety brings ruin,” he warned, as true today as in the time of Pericles, but not exactly an answer to my question. So, I pressed. “Know thyself,” said the Oracle, quoting the inscription on Apollo’s ancient temple. I pressed harder. “Nothing in excess,” he said. I pushed. “The wooden walls will save you,” he said, recounting a vague prophecy made to Themistocles. “Give me the odds,” I demanded. “50:50,” answered the Oracle.

Anecdote: “If you cross the river, a great empire will be destroyed,” said the Oracle, and I vaguely recalled that prophecy from some course I’d taken years ago. The Oracle had spoken these words in ancient times to Croesus, King of Lydia, who interpreted it as a sign that he should sail across the sea to attack the Persians. The prophecy was correct in a sense, but it was Lydia that was destroyed. And so I sat there, searching for meaning in the Oracle’s choice of this prophecy in our discussion. I had asked how the matter of unsustainable debt dynamics would be resolved. In 1946, Social Security and Medicaid made up 2.2% of federal outlays. By 2015 they made up over 45%. And the Oracle shared the histories of 20+ fiscal corrections since 1975. An average unsuccessful consolidation for a nation relied on a 53% tax hike and a 47% spending cut, while a typical successful consolidation consisted of an 85% expenditure cut. Such draconian consolidations are forced upon nations by markets, creditors. The message from the analysis is that decisive government spending cuts have been successful in correcting fiscal imbalances, typically boosting growth, and boosting equity and bond outperformance. However, tax-driven fiscal adjustments typically fail to correct imbalances and are damaging to growth. “Tax hikes fail because they make room for more government spending,” said the Oracle, leaving little room for interpretation. “But if we cannot hike taxes, and if neither party appears willing to make material cuts to spending, and if the interest on our debt continues to compound in ways that crowd out vital spending, then how will we sustain this empire?” I asked the Oracle. “If America can slash regulatory overreach, unlock your energy resources, and support rapid AI advances that in time will lift productivity enormously, then US real GDP could grow at 4-5% for some time.” Problem solved. “So we must grow our way out of this?” I asked. “You must cross the river.”

Good luck out there,
Eric Peters
Chief Investment Officer
One River Asset Management
 
Disclaimer: All characters and events contained herein are entirely fictional. Even those things that appear based on real people and actual events are products of the author’s imagination. Any similarity is merely coincidental. The numbers are unreliable. The statistics too. Consequently, this message does not contain any investment recommendation, advice, or solicitation of any sort for any product, fund or service. The views expressed are strictly those of the author, even if often times they are not actually views held by the author, or directly contradict those views genuinely held by the author. And the views may certainly differ from those of any firm or person that the author may advise, converse with, or otherwise be associated with. Lastly, any inappropriate language, innuendo or dark humor contained herein is not specifically intended to offend the reader. And besides, nothing could possibly be more offensive than the real-life actions of the inept policy makers, corrupt elected leaders and short, paranoid dictators who infest our little planet. Yet we suffer their indignities every day. Oh yeah, past performance is not indicative of future returns.