New CBO report: trend change

The Congressional Budget Office (CBO) has just released the new “Budget and Economic Outlook: 2022 to 2032.” The nonpartisan Congressional Budget Office regularly publishes reports presenting its baseline projections of what the federal budget and the economy would look like in the current year and over the next 10 years if current laws governing taxes and spending generally remained unchanged. This report is the latest in that series.

As deficits increase in most years after 2023 in CBO’s projections, debt steadily rises, reaching 110 percent of GDP in 2032 — higher than it has ever been — and 185 percent of GDP in 2052.

Federal spending (outlays) increase continuously until 2032 when they reach 24 percent of GDP. Since 1946, outlays have reached or exceeded that percentage of GDP only three times — in 2009, 2020, and 2021 (all of which were during a recession or the coronavirus pandemic). By 2032, that high spending will be routine. That doesn’t include spending on any specific problems between now and 2032, such as another recession, epidemic, etc. What’s the chance that there won’t be a major problem within the next 10 years?

In CBO’s projections, the price index for personal consumption expenditures increases by 4.0 percent in 2022. In response, the Federal Reserve tightens monetary policy and interest rates rise rapidly. Real GDP grows by 3.1 percent in 2022, and the unemployment rate averages 3.8 percent. After 2022, economic growth slows, and inflationary pressures ease.

This is an optimistic forecast which returns to 2% inflation by 2024. As an investor, I’m skeptical.

Real GDP grows by 3.1 percent in 2022 in CBO’s projections. After 2022, growth of real GDP slows because of tightening monetary policy, waning fiscal support, and other factors. They show a slight dip in real GDP in 2023-25 which appears to be a mini-recession. But after 2027 they forecast that actual growth equals potential growth of about 2.5%.

The Federal Reserve has already stated that they want to bring the fed funds rate (and presumably longer duration yields that are influenced by their Treasury and mortgage bond sales) to a neutral level which neither stimulates nor retards the economy. This would mean abandoning the ultra-low interest rates which the Fed has kept (with a few exceptions) since 2000.

If the economy grows at 2.5% and the asset markets are not stimulated by artificial monetary pumping (higher interest rates) the stock market will not return to the bubble valuations of the past few years.

Higher fiscal spending will cause inflation if the Fed reduces interest rates so their hands will be tied. It will be hard to avoid stagflation in the next few years.

This CBO report reinforces the market trend change that began in January 2022. The stock market is going down (especially the overvalued profitless tech “growth” stocks) and they are not coming back. The bond bull market (continuously falling interest rates since 1980) is also beginning a trend change of higher interest rates.

What could reverse this trend? A serious recession that would induce the Fed to cut interest rates, starting the inflationary cycle again. That happened in 1975. By 1980, Fed Chairman Paul Volcker crushed inflation once and for all by raising rates above inflation and holding them there, enduring the screams from the asset markets and the fierce 1980-81 recession. Current Fed Chair Jerome Powell admires Paul Volcker so he may stick by his guns. Or he may cave in, as he did in 2018.

The Fed is just beginning to raise rates so it’s hard to tell. But the CBO report (which is optimistic) shows that many strains are baked in the cake. There’s no getting around the inflationay impacts of soaring deficit spending which will pressure the Fed to keep yields high.