Introducing The US Fiscal Risk Watch Report
A new index to track US fiscal risk
By James Picerno | The Milwaukee Company | jpicerno@themilwaukeecompany.com
The US government appears to be on an unsustainable fiscal path. Exactly how and when this challenge is addressed is an open question. But what’s beyond debate is the recognition that the trend of a widening budget deficit has ramifications for markets and the economy.
The Government Accountability Office – an independent, non-partisan government agency that works for Congress – recently advised that the deteriorating state of the federal government’s fiscal health “poses serious economic, national security, and social challenges if not addressed.”
The challenge is deciding how to monitor the deteriorating state of government finances. There’s certainly no shortage of numbers that can be reasonably identified as relevant. But the feedback loop is slippery between markets, the economy and government – and continually changing. It doesn’t help that investors can be fickle at times, focusing on certain metrics one day and moving on to something else soon after.
There are no easy fixes for what ails Washington’s tide of rising red ink. Nor are there fail-safe analytics that will provide a clear, timely warning for investors. Rather, the data in the table below is offered as a first approximation for developing perspective on several key indicators that are relevant to the federal government’s fiscal profile. Unfortunately, it’s not obvious what indicator or indicators will tell us when the government has crossed the Rubicon. The ten indicators, however, are a reasonably relevant set of numbers for quantitatively assessing the ebb and flow of this risk in broad terms.
Three of the ten are market indicators – US 10-year Treasury yield, US dollar in terms of the major foreign currencies, and gold. For distinct reasons, each one of these markets is expected to be sensitive in some degree to the shifting state of US fiscal risk. The remaining seven indicators track various facets of US finances, such debt as a percentage of the economy (GDP) and the government’s monthly budget surplus/deficit.
We also put all ten indicators on a level playing field for a big-picture review. To do so, the data are transformed into z-scores. In the modeling presented, changes that exceed +1 z-score equate with a relatively high-risk state. A change below +1 z-score is considered “normal” or relatively “moderate” or “low” risk readings.
All ten indicators are combined into the Fiscal Risk Index (FRI), which provides a top-down view of the numbers. At the moment, FRI indicates a relatively middling level of risk compared with the readings after the pandemic-induced spike.
Updates are scheduled for one to two times a month, depending on how the data evolves -- or more frequently if there’s a significant change in the numbers.
Although it’s unclear how markets will price in a growing funding gap between government spending vs. revenue, FRI offers a reasonable first step in summarizing how several key indicators are evolving as a proxy for evaluating fiscal risk.
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