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Goldman Sachs warns US spending could push up rates and debt levels

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Goldman Sachs sees a tidal wave of red ink — and it may drag the U.S. economy into its undertow.

Federal deficit spending is headed toward “uncharted territory,” the firm said on Sunday, suggesting that the Trump administration and Congressional Republicans may not be able to count on the economic boost of tax reform for very longer.

In the wake of an ambitious infrastructure plan and a budget that drew fire from virtually all sides, Goldman Sachs said in a note to clients that the federal deficit would reach 5.2 percent of U.S. growth by 2019, and would “continue climbing gradually from there.”

The GOP is counting heavily on the fiscal stimulus provided by tax reform—many companies have announced investment plans and doled out bonuses, even as the majority of taxpayers enjoy lower rates—to insulate them from a restive public in November. Polls suggest that Republicans may lose control of Congress, and President Donald Trump’s own poll numbers hover below 50 percent in most polls.

Yet Goldman Sachs warned that the economic impetus from tax reform may have diminishing returns after this year. “The fiscal expansion should boost growth by around 0.7pp in 2018 and 0.6pp in 2019, but will likely come to an end after that”—listing a litany of reasons why spending and debt would conspire to undermine the world’s largest economy.

While tax cuts are partly responsible, Goldman stated that “projected increases in mandatory spending—this includes Social Security, Medicare, Medicaid, and income support programs—are primarily responsible” for an unsustainable surge in spending.

The dire fiscal backdrop comes against Trump’s spending plans, which have created plenty of critics on the right and left. In a weekly podcast, Caleb Brown, a scholar at the libertarian Cato Institute, branded the Trump administration spending and infrastructure spending “budget buster[s]” saying that overall spending was “very likely” to rise in the coming years despite isolated cuts.

The Congressional Budget Office estimates the level of U.S. debt to gross domestic product (GDP) is currently around 77 percent. If current imbalances hold, Goldman Sachs expects the ratio to hit 85 percent of GDP by 2021. Last year, the CBO issued a dire forecast that the U.S. debt/GDP could skyrocket to 150 percent by 2047, if the trend was left unchecked.

Goldman’s analysts wrote that the “growth effect comes from the change in the deficit, not the level, and further expansion would put the U.S. onto an even less sustainable long-term trend. Second, some of the recent deficit expansion relates to changes unlikely to be repeated, such as the temporarily large effect of certain tax provisions.”

Lastly, “there is a good chance that control of Congress will change after this year’s midterm election, likely making it more difficult to further expand the deficit,” Goldman added.

Recently, the Treasury projected a virtual sea of red government ink, saying it would have to borrow close to $1 trillion this year, and above that level in the years to come. Goldman underscored that fact by saying the Treasury is borrowing at record low rates, but couldn’t expect to do so indefinitely.

The Treasury’s need for more debt is inauspicious, given the recent surge in U.S. yields and a Federal Reserve that’s expected to begin a campaign to hike borrowing costs and withdraw liquidity.

“We expect rising interest rates and a rising debt level to lead to a meaningful increase in interest expense,” Goldman said. “On our current projections, federal interest expense will rise to 2.3 percent of GDP by 2021,” and could hit 3.5 percent by 2027.

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Biden wants Yemen war to end, but may have worsened it, analyst says

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U.S. President Joe Biden wants to end the war in Yemen, but it’s not likely that the conflict can be dialed back anytime soon, according to Jonathan Schanzer, senior vice president for research at the hawkish Foundation for Defense of Democracies.

“In fact, if anything, I think this is likely to make the conflict grow worse,” he told CNBC’s “Squawk Box Asia” on Tuesday.

Biden announced last month that the U.S. will withdraw its support for the offensive against the Houthi forces in Yemen.

Previous administrations under Donald Trump and Barack Obama backed the Saudi-led alliance in its intervention in the civil war in Yemen.

Yemen’s civil war began in 2014 when Houthi rebels took control of the capital Sanaa from the internationally recognized Yemeni government.

A year later, Saudi Arabia led a coalition of Sunni Arab states in support of the Yemeni government to oust the Houthis, a militia backed by Shiite-majority Iran.

We’re simply going to hope that an Iran-backed militia will come to the table and act reasonably. Unfortunately, I think this is wishful thinking.

Jonathan Schanzer

Foundation for Defense of Democracies

According to the United Nations, the war has already caused an estimated 233,000 deaths — including more than 100,000 fatalities from indirect causes such as lack of food, health services and infrastructure.

Schanzer said Biden’s move will not help end the war in Yemen because the U.S. does not have concessions to offer to the Houthis, who now have less incentive than before to make compromises.

“What the Biden administration has done is, it has taken the military option off the table for the United States, even by way of proxy through the Saudis,” he said.

Diplomacy the only option

The U.S. also removed the Houthis from being designated as a foreign terrorist organization, and took them off the Specially Designated Global Terrorist list.

“What is left right now is diplomacy,” Schanzer said.

“The reality that we are now facing is that we’ve taken really all of our other leverage off the table, and we’re simply going to hope that an Iran-backed militia will come to the table and act reasonably,” he said. “Unfortunately, I think this is wishful thinking.”

He noted that the Houthis have stepped up strikes even though the U.S. special envoy to Yemen, Timothy Lenderking, has implored them to negotiate.

Smoke billows above the residential area following airstrikes of the Saudi-led coalition targeting Houthi-held military positions on March 7, 2021 in Sana’a, Yemen.

Mohammed Hamoud | Getty Images News | Getty Images

Schanzer said Saudi Arabia’s continued military operations could be “one of the few pieces of leverage” that the U.S. could use in discussions with the Houthis.

Still, he acknowledged that there is an aversion to being involved in the conflict. “It looks … as if the Biden administration has itself tied in knots a bit,” he said.

It’s unlikely that there will be progress toward ending the Yemen war for now, he said, pointing to the aggression from the Houthis.

“With the swarm drone attacks and the ballistic missile attacks and other acts of violence they’ve carried out in the Saudi state, it’s very, very hard to imagine that the Saudis are going to want to dial back on their reprisals,” he said.

— CNBC’s Amanda Macias contributed to this report.

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House plans to pass Biden Covid relief bill

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The House plans to pass Democrats’ $1.9 trillion coronavirus relief bill this week and get fresh aid to Americans starting this month.

The chamber aims to approve the rescue package in time for President Joe Biden to sign it before key unemployment programs expire on Sunday. The Senate passed the legislation on Saturday.

Democratic leaders hope to get the legislation through the House as soon as Tuesday, but passage could slip to Wednesday as representatives wait for the Senate to send the massive proposal back across the Capitol.

“It could be that we get it tomorrow afternoon and then it has to go to [the House Rules Committee]. And we’d take it up Wednesday morning at the latest,” House Speaker Nancy Pelosi, D-Calif., told reporters Monday.

The bill extends a $300 per week boost to unemployment benefits through Sept. 6 and sends direct payments of up to $1,400 to most Americans. The stimulus money will start hitting accounts this month, Biden said Saturday.

The bill also includes an expansion of the child tax credit, rental payment assistance and funds for Covid-19 vaccine distribution and testing. It directs money to state, local and tribal governments, along with schools.

Speaker of the House Nancy Pelosi (D-CA) speaks to the media on Capitol Hill in Washington, March 4, 2021.

Joshua Roberts | Reuters

Democrats passed the bill in the evenly split Senate without Republican support through the budget reconciliation process. They are not expected to win any votes from House Republicans, as the GOP criticizes what it calls wasteful spending in the bill.

When the House passed a different version of the plan last month, no Republicans supported it and two Democrats opposed it. Despite the lack of GOP votes the first time around, Pelosi is holding out hope for Republican support.

“The House now hopes to have a bipartisan vote on this life-saving legislation and urges Republicans to join us in recognition of the devastating reality of this vicious virus and economic crisis and of the need for decisive action,” she said in a statement Saturday.

While changes made to appease conservative Democratic Sen. Joe Manchin of West Virginia drew criticism from House progressives, the bill appears set to pass the House on Tuesday. The Senate bill limited the number of people receiving direct payments relative to the House plan by capping them at $80,000 in income for individuals and $160,000 for joint filers.

It also reduced the jobless benefit supplement to $300 from $400 in the House bill. The policy will last an additional week, through Sept. 6.

After the Senate passed the changes, House progressives signaled they would vote for the revised plan.

“Importantly, despite the fact that we believe any weakening of the House provisions were bad policy and bad politics, the reality is that the final amendments were relatively minor concessions,” Congressional Progressive Caucus Chair Rep. Pramila Jayapal, D-Wash., said in a statement Saturday. “The American Rescue Plan has retained its core bold, progressive elements originally proposed by President Joe Biden and passed in the House relief package.”

Republicans criticized Democrats for pursuing the relief package on their own. The GOP also targeted what it called wasteful spending not needed to end the pandemic and boost the economic recovery.

Senate Minority Leader Mitch McConnell, R-Ky., argued Democrats wanted to push through “unrelated policy changes that they couldn’t pass honestly.”

McConnell also pointed to a better-than-expected February jobs report as evidence that nearly $2 trillion in spending is unnecessary.

Biden and Democrats have said the country needs the stimulus spending to sustain economic gains and help the millions of people still receiving unemployment benefits or unable to afford food and rent.

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Analyst on outlook for Top Glove, Malaysian glove stocks

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SINGAPORE — The recent plunge in share prices of Malaysian rubber gloves makers is “unjustified,” said an analyst who’s predicting further upside for the stocks.

Shares of Top Glove, the world’s largest rubber gloves producer, have fallen 17.7% this year as of Monday’s close. Its smaller peers Hartalega, Supermax and Kossan have dropped between 18% and 30%.

In comparison, the benchmark FTSE Bursa Malaysia KLCI Index fell 0.9% in the same period.

Staff of Top Glove, the world’s biggest glove maker, check on the production of latex gloves in a watertight test room at one of the company’s factories in Selangor, Malaysia, on Feb. 18, 2020.

Samsul Said | Bloomberg | Getty Images

“We are maintaining our Overweight call on the sector, as we believe the recent decline in share prices is unjustified,” Ng Chi Hoong, an analyst at Malaysian investment bank Affin Hwang, wrote in a Monday report.

The decline in Malaysian glove stocks followed a significant jump last year when the Covid-19 pandemic boosted demand for medical gloves.

Factors hurting investor confidence in the stocks include a potential fall in selling prices of gloves on lower demand as more people are being vaccinated globally, said Ng.

In addition, Top Glove’s plans to list in Hong Kong — its third stock listing after Malaysia and Singapore — also triggered worries that the company is raising funds in anticipation of a weaker outlook, he said.

But those concerns will likely ease, said Ng. Here are his target prices for Malaysia’s glove stocks.

Affin Hwang’s target prices for Malaysian glove stocks

Stocks Monday’s close (Malaysian ringgit) Target price (Malaysian ringgit) Upside
Top Glove 5.04 10.10 100%
Hartalega 9.70 17.00 75%
Supermax 4.21 10.90 159%
Kossan 3.66 9.30 154%

Demand to stay above pre-Covid levels

The analyst said the jump in average selling prices of gloves is not sustainable, and forecast a 30% to 35% fall in prices in 2022. Still, prices will likely remain above pre-pandemic levels for the next two to three years at least, he said.

That’s partly because demand for gloves is expected to remain elevated in the coming years as the medical sector uses more personal protective equipment, said Ng.

He added that he agreed with the report by consultancy Frost and Sullivan and commissioned by Top Glove, which projected demand for disposable gloves to increase by an average 15% annually for the next five years.

Such growth in demand would come alongside a 20% annual increase in supply in the next few years, said Ng.

Top Glove plans to list in Hong Kong

Another development that has driven recent price actions in Malaysian glove stocks is Top Glove’s planned third listing in Hong Kong.

The company said last month that it applied for a “dual primary listing” in Hong Kong that could raise up to 7.7 billion ringgit ($1.87 billion). It said it will keep its current primary listing in Malaysia and secondary listing in Singapore.

Investors reacted negatively to the news on concerns that the additional listing would dilute Top Glove’s earnings per share.

Still, Ng has maintained his “buy” rating for Top Glove and its Malaysian peers. He said the decline in share prices have brought valuations down to levels that are “too cheap to ignore.”

The analyst added that compared with their international counterparts Malaysian glove makers are delivering higher dividend yield and better return on equity — a measure of financial performance.

Top Glove on Tuesday reported a surge in quarterly profits to 2.87 billion ringgit ($695 million) for the three months ended February, from 115.68 million ringgit ($28.03 million) a year ago.

The company said global demand for gloves continued to be “strong,” with the Covid pandemic spurring an increase in glove usage and heightened hygiene awareness.

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