Budget Machinations
Wall Street seems unfazed by all of Washington's red ink
There will be plenty of hoopla in Washington this week as President Bush releases his 2007 budget. Expect pages and pages of explanation about how the estimated $2.7 trillion proposal will spur economic growth, help win the war on terrorism, and end U.S. dependence on oil. There's also likely to be yet another self-congratulatory mention of the administration's continued spending restraint--despite the addition of another third of a trillion dollars to the deficit. The Bush team will focus on the pace of how nondefense discretionary spending--everything from education to NASA--is continuing to fall.
But don't look for much reaction from Wall Street, where corporate finance and investment banking types often roll their eyes at the financial legerdemain practiced 229 miles to the south. The big-money crowd tends to pay more attention to happenings at 20th and Constitution--the home of the Federal Reserve Board, where newly appointed Chairman Ben Bernanke now holds court.
Rubin's gambit. It was not always thus. Go back a few years and you will find story after story lauding the Clinton administration's embrace of the bond market, a strategy hatched by former Goldman Sachs Cochairman and Treasury Secretary Robert Rubin, who sold Clinton on the reverse Keynesian notion that trimming the deficit would reassure bond traders and spur economic growth through lower interest rates.
But all those budget-obsessed bond traders from the go-go '90s now seem disinterested when, according to Rubinomics, they should be in a panic. After four straight years of budget surpluses from 1998 to 2001--totaling $559 billion--the federal government has posted four straight years of budget deficits, adding up to $1.26 trillion. The treasury is even bringing back the 30-year bond--discontinued in 2001 amid large surpluses--with an initial $14 billion auction this week.
Despite the river of red ink flowing through Washington, the 10-year treasury yields half a percentage point less today than when Bush took office.
Why the disconnect? As long as foreigners see fit to repatriate their dollars into treasuries, helping keep U.S. interest rates low and spurring a housing boom, Wall Street seems sanguine about current fiscal policy. "There are no bond market vigilantes out there right now," says Brad Setser, head of global research at Roubini Global Economics in New York.
Another possible reason for such sanguinity: Fears that high deficits will spark higher inflation have largely proved unfounded. Inflation has stayed low, even amid a dramatic rise in the price of oil. "Inflation has been very modest, and that is the biggest single factor affecting interest rates," says Ken Hackel, bond strategist at RBS Greenwich Capital. "And as long as inflation remains modest, rates won't rise dramatically."
Perhaps Wall Street even believes that the deficits are temporary, a view that Bush espouses. The 2007 proposal will probably show that the deficit, after climbing to $337 billion this year from $318 billion in 2005, will begin shrinking again thanks to higher tax revenues from continued economic growth. Bush has also promised to cut the deficit in half by 2009, and the Congressional Budget Office estimates that the budget will move into the black in 2012.
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