Fiscal Policy Is Bigger Bond Risk Than Fed, Pimco’s Clarida Says

(Bloomberg) - Fiscal policy risk is more likely to drive up US bond yields than further tightening from the Federal Reserve, said the central bank’s former vice chair Richard Clarida.

The market repricing that took Treasury yields to 15-year highs last month has now largely run its course, with concerns over the US budget now more likely to take yields above recent levels, Clarida said. The government is seen risking a shutdown over spending as soon as next month.

“If rates do move up, I don’t think it’s going to be because of the Fed, it’s going to be because of the fiscal dysfunction in Washington,” Clarida, now global economic advisor at Pacific Investment Management Co., told Bloomberg TV in an interview. “Even though the Fed’s very powerful, it’s not the only driver of rates and fiscal policy is also a factor as well.”

The US Congress is short on time to reach a temporary spending deal and House conservatives are vowing to disrupt negotiations unless their demands for cuts are met. The US also found itself at an impasse earlier this year due to political wrangling over the debt ceiling.

Investors have started to voice concerns over sustained fiscal shortfalls. Fitch Ratings unexpectedly downgraded America’s sovereign credit rating last month, predicting the country’s finances will likely deteriorate over the next three years.

“If you just look at simple measures like the amount of government debt relative to GDP in most countries, 20 years ago that number was less than 50%. It’s now around or north of 100%, including in the US,” said Clarida, who served as the Fed’s vice chair from 2018 to 2022.

US Budget Deficits Are Exploding, With No End in Sight

He expects the Fed to hold interest rates steady when it meets next week, while indicating it’s still prepared to tighten policy further. He warned there’s a “disconnect” between the new mantra of policymakers — higher-for-longer rates — and markets, which are pricing rate cuts next year.

He also flagged potential risks posed by the Fed’s reduction of its balance sheet, a process known as quantitative tightening. It’s already offloaded about $1 trillion of its bond holdings, but policymakers need to be attentive to signs of growing market stress as it continues.

“I learned when I was vice chair in the fall of 2018, it’s in the background until it’s not and markets can suddenly start paying a lot of attention to QT,” Clarida said.

By Alice Gledhill and Francine Lacqua
September 14, 2023


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