Is US debt a threat to equity market recovery?Introduction: The equity market is marking time in the short term after a vertical uptrend since the beginning of April. There are many issues of fundamental concern, but one is currently front and center: the sustainability of US sovereign debt. Of course, it's far too early to talk about a US public debt crisis, but the new tax bill championed by the Trump Administration envisages raising the US debt ceiling by $4 trillion, putting short-term upward pressure on US bond yields on 10-, 20- and 30-year maturities. Is this a threat to the rebound in US equities since the beginning of April?
1) US bond yields reach macroeconomic warning zone
The Trump Administration's tax bill calls for tax cuts and, above all, an increase in the US public debt ceiling by US$4 trillion to allow the US federal government to continue its massive indebtedness.
The market is beginning to worry about this situation, as US debt is on the verge of surpassing the 1946 record when expressed as a percentage of US GDP. The annual interest burden on existing debt has reached US$880 billion, equivalent to the US defense budget.
Chart showing the evolution of US public debt as a percentage of US GDP
As a result, financial markets are expressing their concern with rising US bond yields on the long end of the yield curve.
Chart showing Japanese candlesticks in daily data tu 10-year US bond yields
Graph showing monthly Japanese candlesticks for the 30-year US bond yield.
2) The market is hoping for activation of the FED put to ease bond tension
This upward pressure on US bond yields may represent a risk for the equity market, as higher US federal government yields will have a direct impact on US corporate borrowing rates.
S&P 500 companies have solid balance sheets and should be able to cope, but long-term bond yields must not rise above 5/6%, as the financial situation of small and medium-sized US companies would then become problematic. This 5/6% threshold has been identified as the macroeconomic warning threshold for the majority of US companies. In such a scenario, the FED would be obliged to intervene directly on the bond market to relieve the pressure.
3) The S&P 500 is overheating in the short term, but the underlying uptrend is technically intact, and remains supported by the new record high in global liquidity.
At this stage, technical analysis of the financial markets suggests that the upward rally since the beginning of April is not under threat. The market was overheated in the short term and needed to breathe. For the S&P 500 index, the consolidation is short-term in scope, and the recovery remains intact as long as the major technical support zone of 5700/5800 points remains intact. The 200-day moving average, shown in blue on the chart below, passes through this price range.
Chart showing Japanese candlesticks in daily data for the S&P 500 future contract
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