Looming Debt ‘Death Spiral’ Will Force Fed to Restart Money Printers Sooner: Expert

Federal Reserve Chair Jerome Powell testifies in Washington, on June 23, 2022. Win McNamee/Getty Images

As the Federal Reserve continues to hike rates into a rapidly slowing economy, macroeconomic analyst Luke Gromen warns of a growing risk of a default-culminating “death spiral” in U.S. government debt that will force the central bank to hit pause on monetary tightening sooner than markets expect, and then restart the money printers full blast to resume monetizing debt.

Soaring inflation has driven the U.S. central bank to embark on a path of quantitative tightening, with market expectations—based chiefly on eurodollar futures contracts—predicting that the Fed will continue hiking for another six months or so before hitting pause.

The Atlanta Fed’s market expectations tracker, which estimates the three-month average fed funds rate using a methodology that centers on eurodollar futures, predicts the Fed will hike no higher than to around 350 basis points, or 3.50 percent.

The final hike is expected to take place at the Fed’s December meeting, with the tracker then estimating a slight and steady drop in the fed funds rate, to around 284 basis points by mid-June 2023.

But this consensus view—namely that the Fed will keep hiking for another six months before pivoting—will face a hard reality check as economic indicators deteriorate and GDP slows, putting pressure on debt-servicing costs and forcing the Fed to bring forward its timeline for a pivot, Gromen argues.

Far Faster Fed Pivot?

Gromen, founder of macro and investment research firm Forest For The Trees, told the Real Vision Finance program in a recent interview that he thinks the last Fed rate hike is barely a month away.

“My base case [scenario] is that what we’re likely to see, in my view, in the U.S. economic data over the next month or two is likely to pull forward the day ... where the Fed is forced to pause hiking,” he said, predicting that “the last Fed hike will take place by the end of August of this year.”

A number of economic indicators—with the notable exception of relatively strong labor market data—suggests the United States is heading for a recession.

Real disposable incomes, real sales, and monthly GDP have all deteriorated over the past three months, along with signs of housing market cooling and a drastic drop in consumer confidence.

The Conference Board’s Leading Economic Index (LEI), which uses a weighted average of 10 indicators to indicate if the economy is improving or getting worse, fell for the fourth consecutive month in June, with the organization’s analysts predicting a U.S. recession is now the base case.

“Amid high inflation and rapidly tightening monetary policy, The Conference Board expects economic growth will continue to cool throughout 2022. A U.S. recession around the end of this year and early next is now likely," Ataman Ozyildirim, senior director of Economic Research at The Conference Board, said in a statement.

Government Debt Default Risk

In the interview, Gromen was asked what factors could trigger an earlier pause in rate hikes by the Fed than the consensus view of around six months from now, and he replied that it would likely be a particular stress in the U.S. Treasury market or credit markets.

“That [stress] could be as extreme as something that we saw at the short end with the repo rate spike in September 2019,” Gromen said, or it could be as subtle as the Treasury market dropping alongside equities.

Gromen added that rising Treasury yields, which move inversely to prices, is “very non-conducive” to the U.S. government’s funding status.

Citing research (pdf) by Brian Hirschmann, managing partner at hedge fund Hirschmann Capital, Gromen said that history shows that every country over the past 200-plus years (except Japan) that hit 130 percent debt-to-GDP—which the United States exceeded briefly in 2020—has gone on to default on its debt.

“Since 1800, 51 out of 52 countries with gross government debt greater than 130 percent have defaulted, either through restructuring, devaluation, high inflation, or outright default,” Hirschmann wrote in his analysis.

Japan is the only example of a country avoiding default despite having government debt greater than 130 percent of GDP, although Hirschmann argues a Japanese default is “inevitable.”

The public debt-to-GDP ratio in the United States hit 134 percent in the fourth quarter of 2020, and in the first quarter of 2022 it sat at 125 percent, St. Louis Fed data shows.

‘Debt Death Spiral’

If GDP continues to deteriorate in the United States and interest rates stay high, Gromen predicts a “debt death spiral” that will make debt-servicing costs unsustainable.

“The ability to do austerity in the U.S. is a complete delusion,” Gromen said.

U.S. policymakers had the chance to impose austerity a decade or so ago, but failed.

“The failure of leadership on both sides of the aisle in the United States and other Western social democracies means this is what you have to do—if you inflate it out, you have to inflate it away,” he said, arguing that the only realistic possibility for the U.S. government to avert a default is to allow inflation to run hot.

But with soaring inflation imposing a massive cost-of-living squeeze on American households and polls showing that inflation has become a top problem for Americans, the Fed appears determined to hike rates aggressively.

If the Fed doesn’t pivot soon in the face of a slowing economy, this risks a “tremendous crisis,” Gromen believes.

‘It’s Going to Be Inflationary’

Besides predicting that the Fed will hit pause at the end of August, Gromen thinks that by July 2023, the central bank will fire up the money printers and resume its program of quantitive easing.

“I think we‘ll be beyond debating a year from now. I think it’ll already be done. I think it'll be back to it,” he said of discussions around quantitative easing and sharply lower interest rates.

Asked what the Fed is likely to do if it pivots and inflation stays above 4 percent, the central bank is likely to adopt some form of yield-curve control, like in Japan.

“Austerity is going to send out that debt death spiral,” Gromen said, adding that policymakers at the Fed “really are stuck between a rock and a hard place.”

Unfortunately, if the Fed eases off the brakes, that likely means inflation will stay high, probably above 4 percent, Gromen believes.

“It’s going to be inflationary,” he said. “It’s going to feel a lot like the U.S. being Argentina with U.S. characteristics.”

“Is this how I want it to go? No. But again, we had 40 years for our political leaders to be adults—and they weren’t on both sides of the aisle. And so this is what you get.”