Bond buyers worldwide, awash in negative-yielding debt, are crying out for fiscal spending. A seven-minute stretch in the German bund market proves it.
That unleashed a sell-off in bunds the likes of which hasn’t been seen in recent months. In minutes, yields “went parabolic” in a move that looked like one massive straight line upward. They shot up even faster than they did after European Central Bank President Mario Draghi gave a relatively upbeat assessment of the region’s economy after its most recent decision on July 25. Kevin Muir, a market strategist at East West Investment Management Co., said on Twitter what bond traders were thinking: “BOOM! Game on! Don’t underestimate how big this announcement is. Fiscal changes the whole equation.”
The watershed moment didn’t last. Germany’s Finance Ministry quickly dashed hopes of widespread fiscal spending, commenting publicly that no decision has been made on giving up on a balanced budget. The official who talked to Reuters warned of such resistance, saying that “the challenge now is how to shape such a fundamental shift in fiscal policy without opening the flood gates for the federal budget” because “once it is clear that new debt is no longer a taboo, everyone raises a hand and wants more money.”
To some, this commitment to fiscal restraint is commendable. It certainly provides a stark contrast to the trillion-dollar budget deficits in the U.S. But when a whopping $15.5 trillion of global debt yields less than zero, including the entire German curve, the lack of government spending could very well be doing more harm than good. Fitch Ratings, for instance, noted in a report this week that rock-bottom interest rates aren’t entirely good news for sovereign nations. While they make borrowing costs more manageable, they also speak to a gloomy outlook for the future:
“The economic conditions leading to structurally lower yields may not be as supportive of sovereign credit. Lower interest rates to some extent reflect weaker potential GDP growth stemming from slower productivity growth and demographic changes. These, along with low inflation, will adversely affect growth in government revenues and put upward pressure on age-related spending, adding to fiscal challenges.”
Simply put, negative yields are a painfully obvious sign that governments have room to take on more debt for projects like infrastructure improvements and climate-change related endeavors. They ought to seize the moment.
Infrastructure, in theory, should be one of the easiest things for Democrats and Republicans to agree upon. Yet it has become something of a punch line and a symbol of Washington’s paralysis. With the U.S. government able to borrow at a near-record low 2.15% for 30 years, it sure would seem like an opportune time to address the 47,000 structurally deficient bridges across the country. Recent examples abound of how this has become a pressing issue, including a railing collapse in Chattanooga, Tennessee, earlier this year in an area the mayor called “one of the most heavily trafficked intersections in the country.” Or perhaps the federal government could be bold and take a more active role in high-speed rail or finally make an additional train tunnel linking New Jersey to Manhattan a reality.
At least some people in Washington understand that spending more on infrastructure would be a near-surefire way to boost the country’s long-term growth potential. Jeffrey Stupak, a macroeconomic policy analyst for the Congressional Research Service, noted in a report last year that direct federal spending on nondefense infrastructure was less than 0.1% of gross domestic product in 2016 and that its relative spending lagged behind most Group of Seven countries (naturally, Germany spent even less). The White House’s Council of Economic Advisers also published a report extolling the benefits of a 10-year, $1.5 trillion program of infrastructure investment.
All else equal, increasing the economic growth potential of a country should boost inflation, which, in turn, should send bond yields higher. This is the feedback loop that bond traders have been craving and thought they might be getting when hearing about a fiscal U-turn in Germany.
Instead, markets are left with the narrative of negative yields and a “safe-asset shortage,” prompted in part by post-crisis banking regulations like Dodd-Frank and Basel III, in part by huge quantitative easing programs among global central banks, and in part by individuals who are living longer and are focused on saving for retirement. Perversely, this seems to have put the banking system at greater risk — shares of Frankfurt-based Commerzbank AG fell to a record low this week, for instance — and has made it all the more difficult for pension plans to meet their promises.
The bond markets aren’t demanding fiscal profligacy. All they’re suggesting is a modest loosening of the purse strings, with money directed toward projects that benefit the overall economy. The problem, of course, is that more spending is usually framed as “bad” while lowering taxes is “good,” even though they both widen the budget deficit. In truth, both have appealing qualities — but only when applied properly.
Infrastructure spending done right potentially solves several structural problems in one shot. It offers construction jobs to those who might not otherwise have one, further adding to record employment numbers. It creates new or improved structures that will be used for decades and will move people and products more efficiently. It will lead to more sovereign borrowing, which feeds the appetite for safe assets. And, most crucially for the bond markets, it could counter easy monetary policy and some of the other forces leading to negative interest rates.
This is a better solution than trying to rationalize guaranteed losses on bonds. The U.S., Germany and other sovereign nations have a clear green light to borrow. It’s up to elected officials to step on the gas.