Once in awhile politics has a way of underscoring longer-term trends in markets. Yesterday's ouster of House speaker Kevin McCarthy highlights a tilting in power towards fiscal hawks in Washington, which isn't a surprise after years of overspending.
It came just hours before US long-term borrowing rates hit a 15-year high. That's not entirely a coincidence.
Whether it's market-enforced discipline or a change in politics, the fiscal pendulum is swinging. That's not just true in the US but also in Europe where pandemic-era waivers of fiscal rules are past their best-before date.
I remember appearing on Canadian TV roughly 10 years ago and making an impassioned point that 'deficits don't matter anymore'. That proved to be right. Markets certainly didn't care about deficits and while it took some time for politicians to figure that out, they certainly did.
Now, the party is over.
That reality is coming at an inopportune time for the green transition, which will be monumentally expensive. I think that change in sentiment has been captured by green energy stocks recently:
To crystallize the point, the IMF warned yesterday about “… a trilemma between achieving climate goals, fiscal sustainability, and political feasibility…”:
Several economies are pursuing emission reduction policies that rely heavily on spending measures, such as increasing public investment and subsidies for renewable energy. Policies to reduce emissions are welcome efforts. Yet, in some cases, they entail large fiscal costs. Policymakers thus face a fundamental trade-off: On the one hand, relying mostly on spending-based measures to reach net zero goals by midcentury will become increasingly costly, possibly raising public debt by 45−50 percent of GDP for a representative large-emitting country, putting debt on an unsustainable path.
I fear that when the history books are written, it's will be revealed that we spent all the green energy transition money on covid, leaving only a legacy of unsustainable deficits and a distrustful, fragmented public.
So while deficits didn't matter for 10 years, they do now or at least they're starting to. That's going to lead to a brutal adjustment in markets, as growth is ratcheted down, taxes rise and tough choices are made on spending. I pity politicians in the social media/rage bait era who are forced to tackle these problems and I don't think Kevin McCarthy will be the last one to be ousted.
The simple way to summarize this for markets is that growth will be lower. In FX, we're witnessing sustained USD strength because of a divergence in growth differentials and I expect that to continue due to the US' extraordinary fiscal privilege. In time, countries that can solve energy scarcity and security will benefit, but building that out won't be easy in an era of restraint.
