The chances of elevated inflation and stagflation (higher inflation with lower economic growth) were greater than people thought, he warned. Yet, US asset prices were high and credit spreads (the differences in yields between securities with similar maturities but different risk levels) didn’t reflect the impact of a potential downturn.
“Credit today is a bad risk,” Dimon said. “The people who haven’t been through a major downturn are missing the point about what can happen in credit.”
“Credit today is a bad risk,” says JPMorgan CEO Jamie Dimon.Credit: AP
In a significant economic downturn, lenders will not lend to companies that are perceived as risky, or demand they pay higher interest rates. The spreads between government bond yields, the most creditworthy companies and higher-risk companies would widen. Default rates and the numbers of corporate collapses would increase.
With a recession, particularly a stagflationary one, companies would face higher borrowing costs to reflect the increased risk even as their sales and profitability come under pressure.
Moody’s may only have been telling people what they already knew, or should have known, but its assessment of America’s deteriorating public finances ought to be unnerving investors – particularly as it appears that, after last-minute concessions from Congressional leaders, Trump’s “One, Big, Beautiful Bill Act” is likely to be endorsed by House Republicans.
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The US, with deficits approaching $US2 trillion ($3.1 trillion) and government debt of $US36.2 trillion already, is facing the addition of another $US3 trillion to $US4 trillion or more of debt over the next decade as a result of the tax cuts and spending plans in that bill.
The bond market will have to absorb that extra issuance of debt as well as the rolling-over of maturing debt, placing upward pressure on bond yields. That would in turn flow through to borrowing costs across the economy
With the Biden administration’s Treasury Secretary Janet Yellen issuing mainly short-dated securities during Biden’s presidency and her successor in the Trump administration Scott Bessent pursuing a similar strategy to keep the pressure off the yields on longer-term bonds, the market’s appetite for US debt will be tested by the surge in supply from both the existing debt rolling over and the new debt flowing from the One, Big, Beautiful Bill.
The ability of the bond market to soak up the volume of debt heading its way will also be challenged by the aftershocks of Trump’s trade policies.
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Tariffs are taxes on domestic consumption, whether felt directly by consumers or absorbed via lower profit margins by the importing companies. When their effects eventually show up, as they will, they will push the inflation rate up and the economic growth rate down.
The increased deficits and debt could, therefore, coincide with a higher inflation rate and a slowing economy, even a Trump-induced recession. An increase in inflation and interest rates even as the economy is slowing is a recipe for something quite unpleasant.
Trump, of course, doesn’t believe his beloved tariffs will impact inflation or growth because he continues to believe, or at least say, that they are paid by the exporting countries.
That’s despite a growing list of US companies warning that they are already experiencing cost pressures from the tariffs and will have to pass at least some of those costs onto their customers.
“He (Trump) maintains the position that foreign countries absorb these tariffs,” the White House press secretary Karoline Leavitt said on Monday.
Why then did Trump attack Walmart at the weekend for warning that it would have to raise its prices to reflect the impact of the tariffs?
“Walmart should STOP trying to blame the tariffs as the reason for raising prices throughout the chain. Walmart made BILLIONS OF DOLLARS last year, far more than expected. Between Walmart and China they should…EAT THE TARIFFS, and not charge valued customers ANYTHING. I’ll be watching and so will your customers,” he posted on social media.
If the tariffs are actually absorbed by foreign countries, why would Walmart or China have to “eat” anything?
The reality is, as Walmart and other US retailers are only too aware, that they are the ones importing the goods and, even if the exporters are prepared to absorb something of the tariff impacts, they and their customers will be the ones bearing the brunt of the costs. That’s been the history of trade wars.
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Walmart’s profits haven’t surprised anyone and, in the very competitive US retail environment, aren’t extraordinary. The group’s profit margin in the first quarter of this year was about 2.7 per cent and its retail margin (earnings before interest and tax relative to sales) a modest 4.3 per cent.
The world’s biggest retailer is always going to post profits in the multi-billions of dollars, but it doesn’t have the profit margins to absorb the tariff impacts in their entirety. Even if it did, the lower profitability would probably mean less employment and investment by the company and lower dividends and a lower share price for shareholders.
It will be American companies, their shareholders and their customers who will “eat” Trump’s tariffs and add to the mounting vulnerabilities within its overly indebted economy.
US investors might be complacent about their-government’s rapidly swelling deficits and debts today, but that complacency will be severely challenged if the sell-off of US assets by more risk-conscious foreigners and US hedge funds continues, the deficits and debt continue to blow out, government revenues shrink as the world’s largest economy contracts and Trump’s tariffs show up in higher inflation and interest rates.
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