While the unprecedented levels of support given by the Federal Reserve during the Covid-19 pandemic have posed questions about the sustainability of its debt, Barings’ Christopher Smart says investors should be more worried about how willing it is to repay. 
The pandemic has prompted extraordinary levels of support from the Federal Reserve and authorities, which have eclipsed measures brought in during the global financial crisis of 2008.
That has also seen US debt levels rocket and raised some questions over the country's ability to repay such huge sums.
Smart (pictured), who is chief global strategist at asset manager Barings & head of the Barings Investment Institute, said that had the pandemic occurred in the past, authorities might not have been able to tackle it.
“There is no good time for a pandemic, but for the US economy there are bad times and there are really bad times,” he said.
“If you want to feel a chill down your spine, just imagine ‘Covid-2008’, with a housing meltdown and a banking crisis on top of the lockdown and recession.
“Or consider the terror of ‘Covid-1980’, with inflation hitting 14 per cent and the Fed’s tools severely restricted.”
He added: “These are more than haunting visions that trigger an investor’s cold sweat; they are useful reminders of why even a few years of large US deficits should – should – still be affordable.”
What is more important than the level of US debt is the affordability of it, said Smart, and that will depend as much on interest rates staying low as it does on delivering greater growth than its peers.
The strategist said the federal budget deficit may hit 25 per cent of GDP this year – depending on the size of the next stimulus packages to make it through Congress – which would rival levels seen during the Second World War, while overall debt held by the public might yet jump another 20 per cent.
While debt levels might reach wartime highs, however, the economic recovery is unlikely to be as strong for the US.
“Debt as a share of the economy will not drop nearly as fast as it did in the 1950s and 1960s because growth will be slower and budgets won’t balance,” said Smart.
“We also entered this crisis with a structural budget deficit near 5 per cent of GDP, and neither Republicans nor Democrats are running on reducing it anytime soon.”
He added: “Even after pandemic costs are addressed, the US faces large bills over the next decade to rebuild creaking infrastructure, cover health and retirement costs of an ageing population and mitigate the effects of climate change.”
As such, an investor holding US government bonds might reasonably ask ‘how long can this go on?’, said Smart.
“The base case should be that the US may well sustain these debt levels for a long time,” he said. “There may be higher risks and a drag on growth, but the chance of ignominious defaults or cascading bankruptcies is likely low.”
One of the most important factors in the sustainability of high levels of debt is low borrowing costs, Smart explained, noting that interest payments have moved lower than they were a year earlier.
“Rates will rise as the economy recovers, but there is little reason to believe they will spike sharply,” he noted. “This is the silver lining to ‘secular stagnation’ from the combined headwinds of technology, globalisation, demographics and more.”
It’s not just the cost of the debt that will have to remain lower, however: trust in the US's ability to repay must also remain high.
“The math is not that challenging,” he said. “If the economy gets back to just 1.5 per cent growth, which is the low end of most forecasts, and the Fed delivers inflation close to its 2 per cent target, nominal GDP growth would be 3.5 per cent.
“If net borrowing costs remain at 1.5 per cent, the debt ratio should shrink by about 2 per cent per year.”
Smart continued: “The greater immediate risk is that the Fed and Congress take their feet off the pedal before growth is firmly entrenched, but for now we’ll have to take [Fed chair] Jay Powell at his word that he is not thinking about raising rates.”
Beyond the ability to repay, there is the question of the willingness to repay ahead of a presidential election between populist incumbent Donald Trump and Democratic candidate Joe Biden.
“This may sound far-fetched after yet another crisis during which global investors flocked into dollar assets as the safest port in the storm,” said the Barings strategist. “Amid the increasingly polarised election debate, it’s often easy to overlook the trustworthiness of boring legal and regulatory institutions.
“It’s also easy to forget the US's record of dynamism and innovation continues to deliver better long-term results than other advanced economies.”
However, Smart said it’s worth noting that the US lost its highly coveted AAA rating from Standard & Poor’s in 2011 because of political dysfunction.
He concluded: “Market confidence may be far more vulnerable to legal and regulatory institutions becoming politicised, election results that look tainted and a political class that ignores global responsibilities.”