In theory, the U.S. federal budget should move to large deficits during times of economic recession. That’s because the government collects less in taxes.
And spending on certain government programs, such as unemployment insurance, goes up. This boost in spending helps reduce the severity of recessions.
Alternatively, deficits should shrink during the good times. A growing economy produces more tax revenue for Uncle Sam, and welfare spending should fall.
But today, we find the federal budget deficit worsening even though the economy continues to grow.
In fact, the deficit is expected to surpass $1 trillion this year — and for each of the next three years — as shown in the chart below.
In order to fund the deficit, the government must borrow.
This means issuing more Treasury securities on top of the $22 trillion mountain of government debt already in existence.
Trillion-dollar deficits, in addition to the trillions of debt already outstanding, led to my prediction for 2020: There will be a revolt among purchasers of Treasury securities.
In other words, investors will grow wary of government indebtedness and demand more compensation. They will do this by requiring a higher interest rate — sending Treasury yields skyrocketing.
My colleague Ted Bauman shows us in his article for today that foreign purchasers of Treasurys are already stepping away.
But there’s one sector that stands to benefit from this scenario.
A Windfall for U.S. Banks … and Your Portfolio
Since the Federal Reserve doesn’t appear to be raising short-term interest rates anytime soon, the difference between short- and long-term interest rates will increase. This is known as a steepening yield curve.
A steeper yield curve would be a windfall for U.S. banks. That’s because banks borrow money in short-term markets and lend it out at long-term rates. A steeper yield curve will boost banks’ net interest margins — a key measure of profitability.
You can turn improving bank profits into your own profits with the Financial Select Sector SPDR ETF (NYSE: XLF).
This exchange-traded fund (ETF) provides exposure to companies in the financial sector that stand to benefit from increasing Treasury yields.
Best regards,
Research Analyst, Alpha Stock Alert
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