The U.S. has run into recessions with a messy fiscal situation before, but never this bad.
When the growth rate stalls, the government usually does two things in response: First, the Federal Reserve cuts interest rates, thereby lowering borrowing costs to incentivize businesses and households to take more risks and spend more. At the same time, the federal government starts ramping up its spending: They add stimulus like tax cuts or infrastructure spending to rev up the engine at the same time that unemployment claims spikes. The deficit surges, and the economy usually finds its footing.
Now, Slok says, both halves of that playbook are compromised.
Start with the Fed. Its main tool is the short-term interest rate, and the goal of cutting it is to make it cheaper to borrow, which requires inflation to be reasonably under control—otherwise the influx of cheap money just makes prices rise faster. But inflation right now is “proving stickier than the Fed expected,” Slok wrote, driven by oil prices, tariffs, and immigration restrictions that have tightened the labor supply.
Now the government side is where that hefty $39 trillion really bites. When Washington runs a deficit, it has to borrow the difference by issuing Treasury bonds to other nations. Those bonds come in different maturities. There are short-term T-bills, which mature in a year or less, and longer-term notes and bonds that take 2 to 30 years to mature. So, if the Treasury already issues a lot of long-term bonds due to the deficit, it floods that part of the market with supply—and is then forced to keep interest rates on those bonds higher in order to attract enough buyers. Those higher rates then ripple through the economy, hiking mortgage rates, making it harder for companies to borrow, and ultimately undercutting the very stimulus the government tries to deliver.
So, to avoid that, the Treasury has been doing something unusual: funding the deficit almost entirely through short-term T-bills, which is essentially the closest thing the government has to a credit card. T-bills don’t move long-term rates that much, so it doesn’t have as much of a spillover effect on mortgage rates and the rest.
But T-bills are just a bandaid: It “cannot continue indefinitely,” Slok wrote, because short-term debt has to be constantly rolled over and reissued, leaving the government exposed if rates rise. Eventually, the Treasury has to go back to issuing more longer-term bonds—and when it does, the flood of new supply pushes longer term rates up as opposed to down, once again tightening the economy.
In this context, a recession would be a disaster, Slok says. As tax revenue fell, and unemployment claims climbed, the deficits would widen to as large as roughly 4% of GDP, Slok estimated, which would be another $1.1 trillion or so on top of current borrowing. That means even more issuance at exactly the moment investors are least sure they want to lend.
The conclusion: “Rates are staying higher for longer across the curve, and the traditional path to value creation through multiple expansion is largely closed,” Slok said, essentially shutting the door on any historic rate-cut cycles like the one Wall Street enjoyed in the fall.
Returns, Slok wrote, will have to come from “the hard work of operational improvement”—earnings growth, cash generation—”and not from the discount rate doing investors a favor.”
