Our Global Chief Economist explains why markets are concerned
about uncertainty around the French and US elections, and how
their outcomes may affect each economy’s debt load.
---- Transcript -----
Seth Carpenter: Welcome to Thoughts on the
Market. I'm Seth Carpenter, Morgan Stanley's Global Chief
Economist. Along with my colleagues bringing you a variety of
perspectives, today I'll be talking about elections, and what
they might mean for fiscal sustainability.
It's Wednesday, June 26th at 10am in New York.
Elections have unexpectedly become a key risk in an otherwise
positive growth narrative for France this year. And there are a
wide range of possible outcomes for the next government.
Fiscal sustainability is one key market narrative we have been
flagging. And in France, the fiscal position is expected to
deteriorate. Our strategists note that the 10-year OAT boon
spreads have widened more than 20 basis points. And in their
view, further discounts on OATs are likely due to the deficit
trajectories in the different political scenarios and heightened
political and economic uncertainty.
In recent work we've done on developed market government
sustainability, we flagged that across DMs, even if fiscal
deficits remain steady, interest expense on the debt will
continue to rise, pushing up the debt to GDP ratios. Larger
deficits would necessarily exacerbate the situation. Austerity is
necessary to stabilize or lower the debt to GDP ratios.
For France in particular, the maturity profile and forward rates
had meant there could be relatively more time for the repricing
to happen; but the market reaction to the election has meant
higher yields, effectively pulling forward that repricing.
Relative to our analysis in the first quarter of 2024, the debt
surfacing costs are already higher.
The election results have now led to expectations of higher
deficits, implying faster rising debt to GDP ratios as well. This
combination of higher rates and higher deficits is
self-reinforcing. The market will pay close attention to specific
policy proposals -- and the coalitions that result from the
election.
For the US elections, debt sustainability has so far been lower
on the list of topics that clients bring up. The elections are
expected to be close. In a recent joint note with our US public
policy colleagues, we noted four basic scenarios: a Republican
sweep; a Democratic sweep; or divided governments with either a
Republican or a Democratic president.
Our public policy colleagues see very different outcomes across a
10-year time horizon for the deficit, ranging from an increase of
[$]1.6 trillion under the Republican sweep scenario to an
increase of about $600 billion in the Democratic sweep scenario,
and the split government scenario is somewhere in between.
Of course, fiscal policy is not the only consideration for debt
sustainability. Tariffs could generate some higher revenues, but
the adverse hit to GDP means that the denominator of the debt to
GDP ratio will fall and push the ratio higher.
Our policy colleagues have also flagged a big range of possible
immigration policy outcomes. The current positive supply shock to
the labor force has allowed for faster GDP growth and
consequently, higher revenues. Under the strictest immigration
policies, the so-called break-even monthly payrolls flow could
fall from a baseline now of just over 200,000 per month to as low
as 45,000 per month.
Such an outcome would imply lower revenues and lower GDP, meaning
both the numerator and the denominator of the debt to GDP ratio
would be pushing upward.
Thanks for listening. And if you enjoy this podcast, please leave
us a review wherever you listen and share Thoughts on the Market
with a friend or colleague today.
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