The US economy reported a 4.9% surge in the third quarter of 2023, driven by a doubled federal fiscal deficit due to a 19% decrease in personal income-tax collections. This reduction was influenced by adjustments in tax slabs and decreased capital gains taxes, acting as automatic stabilisers for the economy.
The Congressional Budget Office (CBO) had initially forecasted a gradual decrease in income taxes as a percentage of GDP. However, a sharp drop to pre-Covid levels was observed instead. Political constraints may pose challenges to further deficit expansion unless additional tax reductions are implemented.
Looking ahead, the replication of the fiscal scenario from 2023 appears unlikely. Projections suggest an increase in the debt-to-GDP trajectory, which could result in more bond supply and elevated US government bond yields. These changes could impact borrowing rates and global capital flows.
These financial shifts are being amplified by the Federal Reserve's quantitative tightening (QT), potentially leading to policy inversion and shrinking dollar availability outside the US. Such conditions could have significant effects on the valuation of financial assets globally.
The potential solution to these challenges may involve the Fed restarting its bond purchasing program. However, this action would likely require either an economic recession or a significant disruption in the global financial system. Such events could spark a debate on debt sustainability, affecting 'fair value' multiples and leading to adjustments in financial markets.
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