Merlin Weekly Macro: Trump, Reeves and Macron have big debt problems

It almost seems as though there is only one story in town these days: The Donald.

Whether it be the Middle East, Ukraine, the Munich Security Conference, NATO defence spending, Davos, tariffs and trade wars, or America’s new empire (to include colonies acquired or appropriated in no particular order: Gaza, Greenland, the Panama Canal and Canada), the common theme is Donald Trump. To say he has made waves and put the cat among the pigeons in the three weeks he has been in office would be a major understatement.

What the world is quickly discovering is the obverse to Trump’s MAGA/America First coin: Making America Great Again is less a process of the US rising above than everyone else being forced to concede. Apart from Russia’s President Putin, there are few if any winners here, even America. Trump might be accruing political kudos among the nationalist constituency at home having other leaders dance to his tune. However, such reductive policies and as importantly the manner in which they are implemented, especially among those who are supposed to be allies of the US, inevitably corrode the integrity of western unity - which ultimately is not good for the US either.

US Debt ceiling: a limit or a target?

Moving closer to home investment territory in the new era of Trump 2.0, the Republican Representatives in Congress have been laying out their first fiscal plans. If under the Constitution the limits of the power exercised by Executive Order are tested through the courts and what is legally allowable, on all matters fiscal it is Congress and the powerful House Ways and Means and Budget Committees which determine the art of the politically possible. Congress cannot be bypassed on tax and the budget.

The debt ceiling, suspended since June 2023, has been reinstated. Not surprisingly the new base of $36.1 trillion is the current amount of US government debt outstanding. House Republicans have drawn up outline plans which will include $4.5 trillion of ongoing tax cuts (the law implementing tax cuts in 2017 in Trump’s first term expires this year) to be part-funded by $2 trillion of cuts in mandatory spending. Mandatory spending is defined as non-discretionary government expenditure and includes major policy areas such as Medicare and Social Security, plus government debt interest. Critically, because there are significant increases planned for border security and defence ($350 billion between them), as well as the half trillion dollars for technology and energy infrastructure, the initial plan suggests the debt ceiling should be raised by another $4 trillion, taking it up to $40 trillion. Given it was Republicans who vetoed an increase in the debt ceiling in 2023 when it was broken by Joe Biden (then at a mere $31.4 trillion), it is a brazen about-turn now to be suggesting more than a 10% increase on an already very high nominal sum, especially when the scale is measured in trillions of dollars, let alone billions. Adding $4 trillion to the debt is the equivalent order of magnitude as the gross domestic product (GDP)¹ of Japan. A bit like speed limits, the problem with borrowing caps is that what is supposed not to be exceeded is instead viewed as a target to be aimed at.

Is gold the canary in the coal mine?

It is more than a curiosity that in the UK in 2022, an unfunded tax cut costing a mere £2 billion precipitated a market melt-down in government bonds and censure by the International Monetary Fund. In short order Kwasi Kwarteng and Liz Truss were shown the door. Yet the US, which is already nursing a 6.6% deficit/GDP and borrowings/GDP of 122% and which has crashed upwards through glass debt ceilings with impunity, seems to escape scot-free despite knowingly proposing the accrual of an extra $4 trillion of debt which arises largely from unfunded tax cuts.

The difference between the UK and the US? Investors can say no to the UK when it is only 2% of global GDP and largely irrelevant; it is much more difficult to say no to the US which accounts for a quarter of the world economy and is the world’s anchor reserve currency, the foundation of the fiat monetary system. If equity and fixed income investors appear relatively sanguine, perhaps the rapid appreciation of the gold price (within a whisker of $3000 per ounce and already up 12.4% year to date) is a sign of underlying apprehension.

Interest rates down, gross funding costs up

As important as the debt itself is the cost of funding. While the interest rate cycle has turned, the US Federal Reserve (Fed) has admitted that the future economic path is increasingly strewn with cowpats. US Inflation has been rising consistently since September and is now back to 3% again, a point higher than target. The prospect of rapid interest rate cuts is minimal (“we’re in no hurry”), as Fed Chairman Jerome Powell admitted in a Senate hearing this week. In response US government bond yields² have strengthened, not alarmingly so but still definitely in the wrong direction when compared with expectations for US interest rates this time last year. Higher-for-longer is now the reality that neither the government nor investors wanted (the government because the interest bill keeps rising, and investors because it is difficult to make money from rising bond yields when bond prices go in the opposite direction).

What is important to remember with the interest which is paid on fixed income bonds is how those bonds are re-financed when they reach maturity. A 5-year government bond issued in February 2020 with a fixed coupon (i.e. rate of interest) of 1.3% which was the market rate prevailing at the time, would be maturing today to be replaced with another with a coupon closer to 4.4%. Consider the financial implication: a $1 billion issue of Treasury notes with a coupon of 1.3% carries an annual cost of $13 million to service it; the annual cost of servicing the same principal sum with a coupon of 4.4% is $44 million, an increase of $31 million.

Rachel Reeves and her own elephant trap

Here in the UK, Rachel Reeves is fast approaching the March Spring Statement in only six weeks’ time. The prospect of growth is as likely as Tantalus slaking his thirst or relieving his hunger (in Greek mythology, Tantalus was punished for boiling up his son and serving him in a stew as a feast for the gods; Zeus, taking a dim view, consigned Tantalus to Hades to stand in perpetuity in a pool of water which he could not drink, and surrounded by fruit on trees he could not reach; what do the Gods have in store for Ms Reeves for her own filial fiscal stew slapping a great big tax on employers, slowly strangling small businesses and farmers, removing the winter fuel allowance from pensioners and causing a collapse in business confidence?).

It will be a significant embarrassment if the March Statement and Spending Review is forced into a full-blown budget only four months after what was supposed to have been Labour’s landmark re-set of the economy. Every possible route out of the fiscal crisis of the Chancellor’s own making has no good outcomes for her: brazen it out and she will be accused of being asleep at the wheel; public spending cuts spell political doom with the unions; breaking her borrowing limits risks a stand-off with the markets and would confirm her as an incompetent steward of the economy; raising taxes when she has said she would not, would leave her credibility with the electorate shot to pieces. Gordon Brown, a flawed but intellectual powerhouse in comparison with the hapless and over-promoted Reeves, used to chew his fingernails to the quick in anxiety and nervous tension; Reeves’s own should be down to the bone by now.

France’s fiscal and financial morass

Finishing this column concerning debt and deficits, President Macron and his new prime minister Francois Bayrou have used the nuclear option again, invoking Article 49.3 of the constitution to ram through a budget without a plenary vote. When Michel Barnier did the same late in 2024, the subsequent detonation cost him his job when he lost a confidence vote. His successor has narrowly avoided a repeat but only because many of Barnier’s fiscal measures have been diluted. Rather than falling to 5.2% in 2025 as under the Barnier plan, Bayrou’s will see the deficit reduce to 5.4% of GDP from 6% in 2024 (though there is little confidence in the reduction). The debt/GDP ratio will still rise to an estimated 115.5% from 112.7%. With the great polarising schism in parliament, the art of the politically possible in France determined that without yet another government falling, the budget could not tackle the deficit (which needs to halve), it merely slows the rate at which the debt inexorably accumulates.

If we think we have problems in the UK with government spending and tax burdens, we are but a mere beginner compared with France. French government spending will rise to 56.8% of GDP in 2025 under the new budget; the UK is around 45%. The tax burden in France is projected to be 43.5% against ours approaching 38%. It is not difficult to understand why countries such as France are exercised by Trump’s tariffs and the demand to spend 3% or more of GDP on defence; for France, that means a 50% increase in its defence budget. With zero room for manoeuvre, how likely is that?

The Jupiter Merlin Portfolios are long-term investments; they are certainly not immune from market volatility, but they are expected to be less volatile over time, commensurate with the risk tolerance of each. With liquidity uppermost in our mind, we seek to invest in funds run by experienced managers with a blend of styles but who share our core philosophy of trying to capture good performance in buoyant markets while minimising as far as possible the risk of losses in more challenging conditions. 

Footnotes

¹Gross domestic product or GDP is the total value of goods and services produced in a country during a specific period of time. It is a measure of the size of the economy.
²Yields are the rate of interest or income on an investment, in this case a bond, usually expressed as a percentage