The International Monetary Fund’s (or IMF) take on future US fiscal policy
In Part 7 of this series, we learned what the IMF believes should be the key priorities for US fiscal policy. This section discusses the IMF’s outlook.
The IMF projects a smaller fiscal drag for the US in 2015. While it expects total US government spending to increase, it’s thought the ratio of government expenditure to gross domestic product (or GDP) will fall in the future. According to the IMF’s Bureau of Economic Analysis, the ratio came in at 36.6% of GDP in 2013, and is expected to fall to 35.5% of GDP in 2019.
Mid-term elections and debt ceiling limits
This February, the Senate approved a suspension in US debt ceiling limits until March 2015. Meanwhile, at that point, the debt ceiling will again need to be raised to avoid a default on US government debt.
The mid-term elections in November saw the Republicans take control of both the House of Representatives and the Senate. This factor could contribute to greater political will to push through legislation. It could also reduce fiscal uncertainty, notably in areas such as determining corporate tax rates, negotiating free trade agreements, reducing the budget deficit, and increasing funding for federal highways, among others.
State-level expenditure set to rise
According to the American Society of Civil Engineers, the US has to spend ~$3.6 trillion by 2020 to make needed infrastructure improvements. This spending was postponed for the past few years due to fiscal austerity following the financial crisis. Now, state and local governments are likely to increase spending on these deferred projects as their fiscal positions are improved. The need to tighten budgets is also reduced as the economy recovers.
Investor impact: A medium-term muni boom?
Due to the huge infrastructure spending requirement, there should be more municipal bonds (MUB) issued to help finance these projects. The $3.7 trillion municipal bond market is likely to shrink for the fourth straight year in 2014. Meanwhile, it’s one of the best-performing bond (BND) (TLT) market categories in the US fixed-income market this year.
The S&P Municipal Bond Index, which provides a broad representation of the muni market, is up by 8.2% year-to-date—through November 10. This is compared to an appreciation of 4.8% in BND, which provides exposure to US investment-grade debt, and 4.1% in iShares iBoxx $ High Yield Corporate Bond ETF (HYG), which provides exposure to US high-yield corporate debt.
TLT, which invests in long-term Treasury bonds, is up by 19.4%. This is due to the fall in interest rates in 2014 that’s tended to benefit long-term debt more than shorter-tenor maturities. Long-term Treasuries have also benefited from flight-to-safety flows, as increasing geopolitical tensions have seen overseas investors flock to safe-haven options.
Major ETFs investing in municipal bonds include the iShares National AMT-Free Muni Bond ETF (MUB), the db X-trackers Municipal Infrastructure Revenue Bond Fund (RVNU), the Invesco PowerShares VRDO Tax Free Weekly Portfolio ETF (PVI), and the PowerShares Insured National Municipal Bond Portfolio (PZA).