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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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Not all of China is recovering from coronavirus hit at the same rate, survey finds

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In this picture taken on September 22, 2020, people commute on shared bicycles along a street during the evening rush hour in Beijing.

Nicolas Asfouri | AFP | Getty Images

BEIJING — The economic recovery in China from the shock of the coronavirus is only happening in part of the country, according to an independent survey by the China Beige Book released Thursday.

The world’s second-largest economy was the first country to get hit by the coronavirus pandemic. More than half the country shut down in early February in an effort to limit the spread of the virus, contributing to a 6.8% contraction in growth in the first quarter. As the outbreak of the disease stalled in March, businesses began to reopen, and the official gross domestic product grew 3.2% in the second quarter. 

Government-released data in the months since have pointed to further recovery overall. China economists from Nomura expect third-quarter GDP to grow 5.2% from a year ago. 

An independent survey of more than 3,300 businesses in the country between Aug. 13 and Sept.12 shows that growth story is intact — in the wealthier, coastal regions, according to the China Beige Book’s early look brief. The firm conducts the survey quarterly.

“For large firms and those based in the Big 3 coastal regions surrounding Shanghai and Beijing, as well as Guangdong–the corporate elite–the economy is accelerating. This is the public face of Beijing’s recovery narrative,” the report said. “But the rest of China — most firms in most regions — are seeing a far more muted recovery. (Small and medium-sized enterprises) and companies outside the core are earning, selling, investing, and borrowing far less than their counterparts.”

The analysis found that third-quarter revenue and profit in every region fell double-digits from a year ago, while most provinces in the landlocked parts of the country saw output and domestic orders decline from the prior quarter.

Jobs situation stabilizes

Employment, which is a priority for the central Chinese government, did see broad improvement in the third quarter, according to the survey. Manufacturing saw the fastest gains in hiring, while retail showed the greatest improvement in sales volume and prices, the China Beige Book said. 

“Geographically, labor market conditions were better than Q2 in every region,” Shehzad Qazi, managing director at China Beige Book, said in an email. “That said, hiring was strongest on the coast, with locales like Shanghai seeing nearly twice the job growth of numerous interior provinces.”

The official, but highly doubted, unemployment rate as measured by the official survey of cities was 5.6% in August, 0.1 percentage points lower than July, the National Bureau of Statistics said last week.

Other underlying concerns

However, again, the broad recovery masks remaining challenges in sectors such as services, which has employed a growing portion of Chinese over the last several years as the government tries to boost the economy’s reliance on consumption for growth. 

Borrowing actually declined among services firms, which were twice as likely to be rejected for loans as businesses in property, Qazi said. 

“The primary Covid impact now seems to be on Services, which saw only marginal improvement over Q2 in revenue, profits, and sales prices, along with no uptick in hiring,” the third quarter brief said. “Either consumers aren’t convinced that Covid is under control or the long-anticipated rise of Services is in greater jeopardy.”

Looking at the longer-term growth prospects of the Chinese economy, other analysts are pointing to other issues that remain unresolved.

“China faces more risks on its current path than is commonly understood and that the country has encountered incidents of stress within its financial system that could have spread to broader crises,” Logan Wright, Lauren Gloudeman, and Daniel H. Rosen from consulting and research firm Rhodium Group said in a report titled “The China Economic Risk Matrix” released on Wednesday. 

“Cycles in the property sector strike at the heart of some of Beijing’s vulnerabilities in containing financial stress. There is no strong record of policymakers in any country being able to deflate a sizable property bubble without negative consequences,” the authors wrote.

They did point out that most analysts, under the presumption that the Chinese government has the will and capacity to intervene, generally describe authorities’ management of economic problems so far as: “When they want to do something, they can usually do it.”

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Bank of Japan, coronavirus, technology stocks

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Stocks in Asia-Pacific were set to trade lower at the open following overnight declines on Wall Street.

Futures pointed to a lower open for stocks in Japan. The Nikkei futures contract in Chicago was at 23,135 while its counterpart in Osaka was at 23,070. That compared against the Nikkei 225’s last close at 23,346.49.

Shares in Australia were also poised to dip, with the SPI futures contract at 5,850.0, as compared to the S&P/ASX 200’s last close at 5,923.30.

Investors will watch technology shares in the region after their counterparts stateside saw losses. 

Overnight on Wall Street, the Dow Jones Industrial Average fell 525.05 points, or 1.9%, to close at 26,763.13. The S&P 500 slipped 2.4% to finish its trading day at 3,236.92 while the Nasdaq Composite dropped 3% to close at 10,632.99.

Meanwhile, the Bank of Japan is also set to release its monetary policy meeting minutes at around 7:50 a.m. HK/SIN. 

In coronavirus developments, Johnson & Johnson said Wednesday it has begun its phase three trial testing its potential coronavirus vaccine. The firm is the fourth drugmaker backed by U.S. President Donald Trump’s administration’s Covid-19 vaccine program, Operation Warp Speed, to enter late-stage testing.

Currencies

The U.S. dollar index, which tracks the greenback against a basket of its peers, sat at 94.389 following its rise from levels below 93 this week.

The Japanese yen traded at 105.37 per dollar after weakening from levels around 105 yesterday. The Australian dollar was at $0.7065 after falling yesterday from above $0.712.

Here’s a look at what’s on tap:

  • Japan: Bank of Japan’s monetary policy meeting minutes at 7:50 a.m. HK/SIN

— CNBC’s Berkeley Lovelace Jr. contributed to this report.

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Stock futures fall following sell-off on Wall Street

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Stock futures fell during overnight trading, building on Wednesday’s heavy losses that saw the S&P 500 tumble more than 2%.

Futures contracts tied to the Dow Jones Industrial Average slid 0.58%, pointing to a more than 100-point drop at the open on Thursday. S&P 500 futures were down 0.64%, while Nasdaq 100 futures dipped 0.90%.

Futures initially opened Wednesday evening in the green, but comments from President Donald Trump that he would not commit to a peaceful transfer of power should he lose the election appeared to hit sentiment.

Stocks continued their September swoon during regular trading hours on Wednesday, with all of the major averages registering steep losses. The Dow Jones Industrial Average closed 525.05 points, or 1.9%, lower, reversing a 176-point gain from earlier in the session. The S&P 500 declined 2.4%, while the Nasdaq Composite shed 3%.

“There wasn’t one specific reason to explain the selling, and in many ways the slump was a continuation of price action that’s been underway since the start of the month,” said Adam Crisafulli of Vital Knowledge. He noted that the tech trade, which cracked earlier in September, has yet to recover. “Psychology around the group shifted and it’s no longer the stalwart source of support it once was. Meanwhile, investors still aren’t comfortable enough with the cyclical/value stocks to even begin to offset the ongoing tech weakness,” he added.

So far in September the S&P 500 has declined 7.5%, while the Dow has shed 5.8%. The Nasdaq Composite has been the relative outperformer, registering a loss of 9.7% as investors rotate out of Big Tech. Facebook, Amazon, Apple, Netflix, Alphabet and Microsoft are all down at least 11% in September.

Looking ahead to Thursday, investors will get a read on the state of the economic recovery when U.S. jobless claims are released at 8:30 a.m. ET. Federal Reserve Chair Jerome Powell and Secretary of the Treasury Steven Mnuchin will also appear before the Senate banking committee.

The testimony comes as Washington struggles to move forward with additional stimulus measures. On Wednesday Chair Powell reiterated that further fiscal stimulus is needed if the U.S. economic recovery is to continue.

“Today’s [Wednesday’s] stock market action is a clear signal that investors are demanding further stimulus, either fiscal or monetary,” said Andrew Smith, chief investment strategist at Delos Capital Advisors. “While most investors are pinning the recent bout of volatility on seasonality and political uncertainty, we have entered a period where a liquidity pocket is present, which has caused the US Dollar to rally, thus hurting risk assets.”

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