Governments have provided massive aid and stimulus packages in response to the COVID-19 induced recession. The International Monetary Fund said in its semi-annual Fiscal Monitor report that governments have committed $11.7T or 12% of global output, as of September 11. As a result, this has led to exploding budget deficits and debt levels around the world. Interestingly, the bond markets which are quick to sniff out and reflect concerns around debt sustainability, have not yet signaled any warning signs.

The U.S. debt-to-GDP ratio (based on gross federal debt held by the public) is expected to breach 100% for the first time since the 1940s. However, one of the reasons the markets may be shrugging this off is that the cost to finance and cover the interest payments on the debt is so low. The US Congressional Budget Office expects net interest payments for the federal government to decline towards 1% of GDP over the span of the next couple of years. This would actually be the lowest level in six decades. (See Chart Below)

Currently, Congress has debated the size and content of the next round of stimulus that would go towards providing much-needed aid to ‘main street’. The White House had upped their offer to $1.8 Trillion. To put this in perspective, the table below shows a simple calculation that illustrates that the additional interest cost of this package would only cost 0.057% of US GDP. Insofar as interest rates remain ‘lower for longer’, this kind of debt and deficit spending is manageable. So far, investors can take comfort in the Fed’s official stance, with Jerome Powell saying: “We’re not even thinking about thinking about raising rates,”

This is not to definitively say that Governments should spend like this forever. Extrapolating this kind of debt issuance may not be prudent. But one should remind themselves to view this under the lens that this spending is not superfluous, but rather necessary to help keep the wider economy and main street afloat during a pandemic.  In JP Morgan’s view, “The need for current deficits…sustain private sector demand [and] the benefits outweigh the costs.” Vitor Gaspar, director of IMF’s Fiscal Affairs Department, said at a press conference last week, “The near-term priority is to avoid premature withdrawal of fiscal support. Support should persist at least into 2021 to sustain the recovery and limit long-term scarring.” Again, this circles back to how long will it take for things to go back to normal, and moreover, when will we get a vaccine? This continues to be the binary event that influences the critique surrounding the pace of growth in debt and deficits.  With that said, we should all still be cautioned that there may be unprecedented consequences as the amount of debt accumulated results in less flexibility to respond to geopolitical, natural disasters, climate and other emergencies in the future.