As the global trade war continues to escalate and financial markets experience new turbulence, multiple signs indicate that economic uncertainty is intensifying worldwide.

Image source: Global News

Demand for global bonds is rapidly cooling as investor confidence in the fiscal sustainability of major countries, including the U.S., wanes.

NerdWallet Canada financial expert Clay Jarvis stated: "The market is generally uneasy about the U.S. government's fiscal policies, including trade tariffs, the newly introduced tax cut spending bill, and how these measures will affect America's long-term finances."

"It is precisely these concerns that have shaken the bond market," he added.

U.S. debt expansion reduces bond attractiveness

The current total U.S. government debt has exceeded $32 trillion, with a large portion of tax revenue used to pay interest.

The budget proposal recently put forward by U.S. President Donald Trump has just passed in the House of Representatives and is expected to be submitted to the Senate for voting soon. The bill includes a new round of tax cuts and other fiscal expenditures, further fueling investors' concerns over the U.S. Treasury's ability to repay its debts.

If investors believe the government lacks the capacity to repay its debts in the future, they will lose interest in government bonds, especially long-term ones.

This is akin to banks refusing loans to individuals with poor credit scores.

For instance, the U.S. Treasury recently issued a batch of 20-year long-term bonds, but the response was lukewarm, not selling out as quickly as expected. To attract buyers, the interest rate had to be raised above 5%, which led to a downgrade in the credit rating by Moody's, the rating agency.

Toronto University finance professor Andreas Park explained: "When bond ratings are downgraded, investors demand higher interest rates, increasing the government's financing costs."

"The government can only choose to raise taxes or borrow more, which further leads to a vicious cycle," he continued.

Tax cut policy may worsen deficits, triggering a chain reaction

The tax cut plan proposed by Trump in the new budget proposal could further increase the government's deficit.

Image source: Global News

Once fiscal deficits continue to worsen, the government must either raise taxes or find alternative revenue sources to repay debts.

Moody's downgrade action also became one of the triggers for last week's stock market crash.

Montreal Bank (BMO) Chief Economist Doug Porter said: "The U.S. fiscal situation is concerning, and when Moody's downgraded the AAA rating of the U.S. government, the problem became more apparent."

"This is the third rating agency to downgrade the U.S. government to non-AAA status, driving up long-term interest rates and meaning that the cost of borrowing for the U.S. government is becoming increasingly expensive."

Uncertainty spreading globally

The uncertainty in the U.S. is only part of the global debt issue.

In developed countries, government debt levels are rising universally, making traditional "safe investments" such as government bonds less attractive.

"Global investors are cautiously choosing where to allocate their funds," Porter noted. "Not only the U.S., but we see long-term interest rates rising in Europe, Japan, and even Canada."

When governments allocate more budgets to repaying debts, spending on social services and public projects decreases, leading consumers to tighten consumption and exert downward pressure on the economy.

Jarvis warned: "This is a warning signal indicating that the government may be making fiscal decisions that impact social service capabilities, potentially forcing cuts in the future."

Canada's bond market may become a "safe haven"

In comparison, Canada's bond market is still considered a relatively safe option.

Porter stated: "Foreign investors still have strong confidence in Canada."

"Our inflation is low, our economy is weak but our overall fiscal situation is sounder, which keeps Canadian bond rates below those in the U.S.," he explained.

For Canadians, this wave of uncertainty comes at a time when the Bank of Canada is about to announce a new round of interest rate decisions, which will affect various borrowing costs, including mortgage rates.

According to the latest data from Statistics Canada, the outlook for Canadian inflation is stabilizing, and the market widely expects the interest rate to remain unchanged on June 4th.

Original article: https://www.toutiao.com/article/7509227456865075727/

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