Outlook

September 1, 2025

Investors And Markets Should Be Careful What They Wish For

There’s much wisdom in not discussing religion, politics and money at the family dinner table. As to the latter two, I’ve occasionally taken heat for mixing them at this "table" as history is replete with examples that a nation’s economic health and its governmental and fiscal and monetary policies are inextricably linked. Over the short term, equity and credit markets may not be particularly sensitive to policy directives, but over the longer term, they certainly are.

Long ago, the Maginot Line between the federal government and the private sector (let’s call it Wall Street) was breached in small and large ways alike. But I would argue that we have entered yet a new, and perhaps less obvious, phase that is tied to the government’s stressed balance sheet.

Keeping in mind that the federal government will have "income" of about $5 trillion this year while spending $7 trillion (a roughly 35% deficit), the current $37 trillion deficit (which is about a quarter-million-dollars for every U.S. household) is expected to expand to $55 - 60 trillion in the next 10 years.

In an attempt to backfill that gnawing hole (and also encourage in-shoring while growing middle-class jobs), President Trump is aggressively moving on multiple new fronts. While trade and tariffs have received the most attention, more recently, he’s engineered an equity stake in a private business (Intel), has involved himself in C-suite decisions, and has come to favor specific companies and industries he believes will most help the economy to grow.

Nine Terrifying Words
"I’m from the government, and I’m here to help." Though expropriated by President Reagan, he deployed those words to show his resolve in downsizing government (he only slowed its growth). He also lessened its role in the private sector (where he enjoyed far greater success), deregulated and/or privatized government services including satellite communications/telecom, airlines, railroads and energy. And like President Trump, he also reduced corporate and individual tax rates. Moreover, he hired management consultants to examine government spending and make recommendations to himself and Congress. (They did not have the power to act unilaterally.)

Granted, these moves took place nearly a half-century ago, and the U.S. economy’s debt service challenges are now far different and far worse. (The federal deficit has grown to 123% of GDP, up from 32% in 1980.) But with respect to governing, trying to wrest control of the Fed into cutting interest rates and control money supply may feel okay now, but it may not later when an independent Fed could reveal its true value.

During the 2007-’09 Financial Crisis, the Fed’s independence was crucial in stabilizing the credit markets (and the economy) when it slashed interest rates to near-zero, implemented quantitative easing, and also created lending facilities to inject liquidity into the credit markets. It and the Treasury were also central in stopping outflows in "ultra-safe" money market funds. While impossible to prove, a politically controlled Fed may not have been as successful in bringing disparate parties together, including the president, Congress, money center banks and foreign central banks.

Whoever occupies the White House in coming years faces the unpopular task of reducing spending generally, and social spending in particular. (That will likely be a one-term president!) But this won’t (or shouldn’t) fall on the president’s shoulders alone.

Federal cuts to state-run programs in healthcare, transportation, education, etc. will soon impact state and local governments. Though often overlooked in the debt debate, collectively, they employ far more Americans than the federal government.

Some perspective: With rounding, the U.S. labor market is roughly 160 million people. Thirty million (or 19%) are employed by state, local and federal governments. While four million are employed federally (including 1.3 million active-duty military personnel), states employ eight million whereas cities, towns, etc. villages employ 16 million. Viewed another way, Uncle Sam’s $6.75 trillion budget in FY ’24 was 23% of the nation’s GDP, with 17% attributable to state and local spending. With 40% of the country’s GDP tied to all government expenditures (or more precisely, your taxes), the economic ties between the public and private sectors are indistinguishable and co-dependent.

Over the long term, breaking that co-dependency is essential, but it’s not inevitable. (Many countries — including democracies — have defaulted on their debt, ushering in years of economic pain and political dysfunction.) While technology advances such as AI should accelerate productivity and increase GDP (thus shrinking relative indebtedness), that cannot be counted upon — especially if economic gains don’t benefit America’s struggling middle class.

Of course, this is a long wind-up to a topic I’ve visited on other occasions: the outlook for U.S. Treasurys. In the near-term (a few years, at least), their credit-worthiness remains strong, though diminished. And as unpopular as credit rating agencies may be with the government and others, rising U.S. indebtedness will certainly lead to further credit downgrades which, in turn, will depress their value.

Because of U.S. "exception-alism" (which can be thought of as America’s unique economic and geopolitical might), credit agencies may be a bit more generous with their ratings than our distressed balance sheet would otherwise suggest. That’s important to keep in mind, especially as so many other countries hold our debt: If our financial house is in disarray, theirs may be too.

As millions of us Baby Boomers keep moving into retirement, our risk tolerance decreases, our need for income rises, as does our need for fixed-income securities like Treasurys. To that end, short-term Treasury and corporate bond funds should serve you well right now. But should budget deficits keep growing, Treasurys of all maturities, (especially the long bond) may create unnecessary portfolio risk. If you think that’s a scary proposition for us elders, it’s far scarier for our kids and grandkids.

— John Bonnanzio