Welcome to the No More Risk Better of Credit Sites Podcast. I'm Winnie Caesar, the Global Head of Strategy. And I'm Zach Rifis, the Credit Sites Senior Investment Grade Strategist. As strategists, we aim to make sense of the macro and the micro, highlighting opportunities and the risks facing the fixed income markets.
As important as the macro call may be, we understand that credit investing at its core comes down to keen single name selection and we have credit sites benefit from the expertise of our team of over 100 analysts across the US, Europe, and Asia. This podcast offers a look at the conversations that we have with our analysts on a regular basis. If you are an investment professional focused on the wide universe of fixed income, you'll want to give this podcast a listen. Hello, everyone.
And welcome back to the credit sites podcast. This is Winnie Caesar, Global Head of Strategy at Credit Sites. And today I am absolutely delighted to have Cedric Chihab, the Chief Economist for BMI, a Fitch Solutions Company joining us once more on the podcast. Cedric, it is a joy to have you here.
Thank you so much for inviting me Winnie. It's always really fun to talk to you guys. It is super fun to talk to you as well. I really enjoy our dialogue and we're going to get a little bit spooky today in honor of the Halloween holiday.
We are going to start talking about some potential tricks that could hit the US economy and think about recession, fear or angst, which has basically gone away lately. So we're going to bring that back into the conversation. And Cedric, let's start with a little bit of context. Since the Fed started the taking cycle all the way back in 2022, which feels like a million years ago at this point, recession expectations have really shifted.
You know, at first it was the expectation that a near term recession was absolutely unavoidable as the Fed was tightening policy. But then the US economy really managed to outperform, held in much better than people were expecting, even with a pretty significant dose of market volatility and some bus stops in crypto and tech and some other things. Now with 2025 just around the corner, the Fed now proactively cutting rates. What's your view on recession and how does that compare to what the market is expecting?
Well, the good news is that the view isn't as spooky as your intro and we expect that the US will actually experience a soft landing next year. And that's growth from above trend of about two and a half percent this year to about trend growth, maybe a little bit below it, maybe 1.8 percent next year. In terms of the probability of recession, the market is pricing in about maybe 30 percent probability of a recession in the next 12 months. We think that's about right.
Maybe we'd add a couple of points to that. I think the risk for us is that several elements of the business cycle are quite late stage. So especially the labor market. And this means that the risk of a policy mistake remains elevated compared to, let's say, a few quarters ago.
And that's because what we think the US has overly restrictive monetary policy. You could potentially see some new supply shocks, possibly on the back of geopolitical tensions or even the US election. So just to kind of contextualize that comment on restrictive monetary policy, real interest rates remain about 2.5 percent positive. And we think that's a little bit tight for where we are in the cycle.
At the same time, the Fed's reaction function to any sharp pick up in energy prices or inflation expectations is probably more sensitive than it used to be, just because of the memories of 2022 or so fresh in their minds. Yeah, absolutely. 2022 and the whole transitory debacle, I'm sure, is very fresh in the minds of many of the FOMC committee members. Now I think that a lot of people are really concerned about something you mentioned, which is the outcome of the upcoming US presidential election.
And whether that could really alter the broader economic trajectory, maybe throw it off course. Now I'd say from talking to clients, a main concern, possibly the top concern, is that a Trump victory combined with a red wave especially could lead to a recession due to a supply side shock. And how are you thinking about the outcome of the election with regard to economic momentum? Yeah, that's really top of mind of our clients as well.
Our working assumption had been that Harris, who was leading in the polls up until about two weeks ago, would eke out a tiny victory, which combined with the divided government, would mostly lead to kind of broad policy continuity, pretty predictable and a growth environment over the next few years or so. Of course, the race has become much tighter and now it feels like a real toss up and it could go either way. In regard to whether a Trump presidency would lead to a recession, I think that's very hard to answer because it depends on several factors, but primarily on what Trump is actually going to do if he were to be elected president. Now if you take his statements at face value, he would implement tariffs and actually he hasn't stopped talking about tariffs, both as a way to rebalance trade, but also as a way to fund tax cuts.
And in recent days, he's continued to just double down on the concept of tariffs, revenue replacing tax revenue. And so for us, we think it could be a negotiating tactic, but ultimately he likes tariffs. So a 10 to 20% like a tariff on all or most trade partners combined with a 60% tariff on Chinese goods would be a massive supply shop to consumers, we think. And that could lead to a sharp increase in imported prices.
At the same time, Trump wants to deport millions of irregular migrants, which could create a shortage of workers in key areas such as retail, construction, agriculture, which in turn would put upside pressure on prices and wages, for example. And as I mentioned before, the Fed's reaction functions is a bit more sensitive to inflation and inflation expectations. And the Fed could end up having to raise interest rates in order to re-anchor inflation expectations if they start to rise. Of course, some tax cuts in the corporate sector would help the economy, but this would probably be more than offset by the supply shop that Trump policies would suggest.
And also the tax revenues collected from tariffs would probably be insufficient to offset some other tax cuts that he suggested. So at face value, this would seem to be like it will be a shock to the US economy and would likely lead to recession. And it doesn't even take into account the potential for retaliatory measures from other countries. For example, China and Europe could impose tariffs themselves, China could restrict the exports of rare earths and metals, which are important for manufacturing in the US, and that could potentially delay some of the US's ambition to increase their semiconductor prowess.
But of course, Trump might ultimately prove much more pragmatic as policies might take time to be implemented and won't be implemented all over one go. And this could potentially soften the impact from those supplies I trust. Yeah, I mean, it's so hard to game theory out all of the potential moves that Trump may make and also the timing of everything. And so just one follow up first, like, let's say that Trump day one, 20% global tariff, 60% on China, that leads the US economy into a recession.
But I would imagine it would be a global recession, right? Like the countries outside the US wouldn't necessarily have the momentum to kind of withstand, first of all, severe contraction in the US and second of all, the tariffs imposed on those countries, right? Yeah, I think that's a fair assumption. So if you were to get a recession in the US plus with tariffs, that would hurt Eurozone growth and Eurozone is barely growing.
So that would probably take it back to slight contraction. Japanese exports could be hit, Japan's supposed to recover next year, but maybe that gets stalled. China are currently forecasted for about 4.5% growth next year, maybe a little bit higher, shave off maybe one to two percentage points. So yeah, growth would look pretty bad globally, I would say, especially if you have another instance where the interest rates in the US are higher and then you see another wave of strength for the US dollar that would tighten global liquidity as well for emerging markets.
So it wouldn't be a fun place to be if you're an EM policy maker. No, absolutely not. I mean, I don't think it's going to be a fun place to be if you're a monetary policy maker, irrespective of DM or EM to be frank, and especially with DM fiscal deficits looking a little more like EM these days, there's that additional thing. And then from just a timing perspective, okay, let's say we actually have a really clear election outcome on November 6th, which would be amazing because the most recent elections have been kind of a drawn out process.
If we do see a Trump victory or red wave November 6th, the knee-jerk reaction by the market is going to be tariffs, inflation. We've already seen yields move quite significantly higher, but then the actual impact of these things takes more than 24 hours to work their way through the economy. So you're stuck in this limbo for a fairly extended period of time trying to figure out what is the market getting right and what is the market getting wrong. And at the same time, if you see volatility yields rise, borrowing costs rise, that just adds fundamental pain to the picture more broadly.
So it seems like we could be in a very extended period of challenge. Am I reading that right? I think what we are touching on is kind of the sequencing of policy almost. So a red suit is favorable for Trump and the Republicans to enact policy, of course.
And we think the primary or the first thing to address is probably the tax cuts and jobs acts at the extension. And you also have the debt ceiling negotiations that they probably want to, well, they probably have to pair with that. So I think that's possibly one of the first things you're going to do from a legislative perspective. Trump can implement some tariffs or some protection measures unilaterally, but I think if they're very extensive and more pervasive, then you need Congress's approval.
So certainly the tariffs, if much more widespread, could be implemented on a short term basis, but then if they were to be more sustained, they'd have to have more legislative support there. So that could take longer. That could cause a lot of uncertainty for sure. Okay, that's super helpful because I think that a lot of people just think of tariffs, executive action.
We can just do it from day one. I'm the president because I say so. So knowing that there actually is some other congressional authority required, I think is a very helpful thing to keep in mind. Yeah, some things you can do, you know, literally others would require congressional support.
You know, moving away from the political side of things. And as someone who lives in a swing state, I would certainly like to move away from the political side of things because I am up to my eyeballs and it lately. Now it does seem like the election talk has really overtaken the recession talk these days. Why do you think we've moved away from talking about recession at all?
I think there are a few things. In terms of the election, as we get closer to the election, of course, that takes center stage. But from a macro perspective, we've seen some improvement in the economy. So first, we saw some GDP statistics be revised higher in particular, gross domestic income.
And that meant that households and consumers are actually looking a little bit stronger. That was initially thought. So savings rates are higher, for example. And this means that consumers haven't really been dipping into their savings to feel consumption, which had been the assumption before, just because that's what the data was telling us.
The first thing to think about is that from a manufacturing perspective, we think that the manufacturing sector could perhaps strengthen next year as EV and chip production starts to come online. And I think that's a view that's becoming a little bit more mainstream in the sense that actually the manufacturing sector could see a little bit of an improvement. Now the second dynamic is also related to the consumer, was the fact that we got a really good job creation recently. So in September, the US added about 254,000 jobs.
And that was further bolstered by a two month revision of 72,000 jobs higher as well. And this suggests that the labor market is doing good and really then helped to relate the fears of jobs-induced recession in the near term. And the third dynamic, I would say, is the fact that the Fed not only started to cut interest rates, but it cut by 50 basis points. Some are looking at that and saying, oh, that was a mistake.
But basically, it means that the Fed, if needed, can jump in pretty quickly. It's happy to do so if it feels it's behind the curve. And oddly, even though financial conditions have tightened a little bit since the Fed actually cut a few weeks ago, generally speaking, expectations for more interest rates are good for easing financial conditions. And so I think those are the major factors.
Now, what's interesting is that because of the stronger activity data, I think markets have re-evaluated maybe the pace of cuts. We've also had a little bit of a hot inflation print. And so the Fed might just slow the pace and the magnitude of cuts going forward. And that being said, we still think that easier financial conditions more broadly will help to reduce the risk of recession over the coming months and quarters.
Yeah, all these things make good sense. I think the key of the Fed is trying to be proactive. People are really looking at that and thinking, OK, this is going to help continue the party. Let's keep it going.
But one question that does come up quite frequently in my discussions with both the broader analysts, team at credit sites and with clients is how do we stay ahead of the data and presumably the Fed and a potential slowdown or recession? So many of the major indicators, for example, the unemployment rate are lagging rather than leading indicators. So how do we keep an eye out for whether things are actually getting worse? Yeah, that's the holy grail of macro, I think, right there.
Tell me the answer, Cedric. Well, we track several cyclical and structural indicators to try and assess the risk of an economic downturn. You see a lot of analysts actually focusing on business cycle, business cycle trends and leading indicators. And I think that's probably the right way to do it.
The problem is that no two cycles are the same and sometimes the relationships across them don't hold either. So it's quite tricky. So from a markets perspective, let's say the yield curve has a relatively good track record prediction recessions, although it's been a little bit less reliable this time round. Second, related to the yield curve is the stance of monetary policy, which as I mentioned before, we think is quite tight in real terms.
And that's not only tight compared to previous cycles, but also in terms of where we were pre-COVID, the labor market, that's a mean reverting series. So when it changes trends, you've got to keep a close eye on it because it can go for several quarters. I think lately we're focused more on the layoff rates just to see if there's a pickup in companies letting go workers rather than actually additional supply, which is moving the unemployment rates. And there are other typical warning signs that we look at.
So for example, credit spreads typically widen ahead of recessions. There's typically also weakness in the residential sector, which we're seeing currently as well as layoffs in kind of those more sensitive sectors like construction and manufacturing. So those are kind of the higher frequency indicators I typically track. And then from a structural perspective, I think you'd also want to look at a few things.
For example, is there a lot of debt growth, particularly in the private sector? What do household savings look like, et cetera? Yeah, lots of really good things to keep an eye on for sure. And I guess you're just telling me that if credit spreads are widening, I need to let you know so that you can keep that in mind when in doubt, blame credit spreads.
That's what equity spread is always do when they're asked about kind of the health of the market. They're like, well, credit spreads are tight and so everything's fine, which I always think is funny. So on the yield curve, this has not been a particularly accurate indicator of recession in this cycle. And I think you could maybe argue that it was not that great in 2018, 2019 as that ultimate recession that we did hit in 2020 was a product of the pandemic and not necessarily the business cycle.
That would have happened absent COVID, but we don't have that info. How are you thinking about this evolving role of the yield curve as a recession predictor, given involvement of central banks in the market and a myriad host of other factors? That's a really good point. And it kind of goes back to what I said about different indicators might be helpful, more helpful or less helpful for different cycles.
I guess the way I'm thinking about it is that it might not be the inversion of the yield curve per se, but more about how incentives for borrowers and lenders change as short-term rates rise or fall sharply. I think that's the more important that the short-term end of the curve is more important. So typically, a rise in short-term rates means that consumers and businesses have to direct more money to debt servicing rather than consuming or investing. At the same time, as debt becomes more expensive, less new debt is taken off.
And from a supply perspective, banks are more cautious due to concerns around asset quality and then they'll lend less. And in addition, they could just park their money in short-term instruments rather than lending out and taking the risk of non-performing assets. So I think what happens is that you have less demand and supply of credit. And I think this is particularly important if the proceeding economic growth was driven by an expansion in credit, because what you have then is the change in credit is much lower or even negative, and that starts to hurt the economy.
And usually what happens is that interest rate increases start to bite as the economy is late cycle. So you have these kind of two dynamics where short-term rates can lead to a significant change in the amount of credit taking out on the economy and also what's happening when the economy is late cycle and more vulnerable. So that's how I think about the yield curve. So it's more of a short-term, the short-term rates rather than the long-term rates.
Although the long-term rates is telling you that investors expect slower growth in the future, and I think that basically reduces the incentive for long-term investment as well. So that's another factor, which pulls money out of the real market and puts it into short-term securities. So that's how I think about it. Yeah, that's super helpful.
And I think that the big thing that people are grappling with is this cycle has just been so strange from 2020 and fiscal stimulus and monetary stimulus, trying to connect these dots of where is the cash flowing. There was a debt-fueled credit expansion at the height of COVID, but at the same time, we also managed to hit peak earnings at the same time as well. And then things have shifted. So trying to figure out at what point does the stimulus party stop and the stimulus hang over really kicks in has been so tricky, just trying to quantify that momentum of liquidity in the system.
So I guess let's go back to maybe a prior period where the Fed managed to make like Simone Biles and stuck the landing. And we have to really go back to the 1990s to find similar characteristics in the broader economy and monetary policy with rates at relatively elevated levels. We've also seen some economists saying current conditions are kind of like the 1990s soft landing. Can you walk me through some of the similarities and differences between now and that period?
Yeah, that's a... It's an exercise we actually did because everybody talks about the 1990s and mid 1990s. That's when essentially the Fed engineered a soft landing. And it's one of the very few times that it's successfully done.
So it's done so in the past before, but that's the most... The one in people's memory, at least recent memory. So in terms of similarities, a few things stand out. What we know when we track the data is that manufacturing PMIs have weakened in both instances, which is quite interesting.
Real policy rates are roughly tracking around the same level, around 2.5%. Both periods saw productivity growth pick up as well as a slight softening of non-formed payrolls. So slight softening of the housing market. And that's really induced by Fed tightening.
And we've also seen 30-year mortgage rates come down over both periods as they track expectations, although they've currently risen a little bit. But I think there's some pretty big differences as well. So for example, the fiscal deficit stood at around 2% back then. And that's because Clinton had embarked on a multi-year period of fiscal consolidation.
And government debt was around 60% of GDP in falling. In contrast to today, of course, the deficit stands around 6 to 6.5%. And government debt above 110% in its rising. So that's a big difference.
If you look at some other differences. So household debt is a bit higher, at about 70% of GDP. But it's trending lower, as households continue to, I guess, de-leverage relative to the economy. Whereas in the mid-1990s, it was about 60% and it was heading higher.
So they were kind of re-leveraging. And something also interesting is consumer credit was growing very robustly back then. At about maybe, I remember we'd be about 5%, or 6%, whereas now it's tracking about 2%. But the biggest difference, in my opinion, and the one that has, potentially, the largest economic implications is the unemployment rate.
So in the mid-1990s, the unemployment rate was falling, was trending lower, and stood around 5%, whereas now the jobless rate is much lower at about 4.0, but it's rising. And the issue is that if the trend of rising unemployment continues, then this poses a risk to the labor market when it trends the trends. So that's kind of the big difference, I would say. That is super helpful.
I would also like to call out that a lot of the mid-1990s fashion is back in style. So what's old is always new, again, in apparently, economic cycles and fashion. And we also know that not all recessions are necessarily made equal. In recent memory, we've had some doozies.
We had COVID, we had the GFC. Some are definitely worse than others. And then there's some a little bit better. And we have the defining characteristics or the sectors that are in the crosshairs are also quite different.
How can we differentiate the different types of recession? And so tell me specifically, what's the next recession? Thanks for that. I don't know if I'm going to live up to your expectations, Gweni.
Sorry. So yeah, it is true. There are different types of recessions, and that really depends on the cost, as well as the underlying fundamentals and, of course, the policy response that comes with the recession. So all those three factors influence the magnitude and depth.
So we think that recessions can be generally categorized into three types. So you have income statement recessions, event-driven and supply-side shock type recessions, and balance-shaped recessions. And income statement recessions typically triggered by tighter monetary policy that leads to reduced discretionary spending by households and businesses as they have to spend more money servicing their debt. And these recessions are usually short-lived at the average of about eight months or so, and they recovered relatively quickly once interest rates occur, because that was really the primary cause.
Then you have event-driven recessions, and that's caused by external or exogenous shocks, such as oil prices or the pandemic. And this varies significantly in duration and severity, just because you don't know exactly what the shock is. Depends on the magnitude as well. But that shock and a good example is the pandemic.
It was extremely aggressive, but very short, relatively, right, once we reopened the economy. Then you have balance-shaped recessions, and these are the ones to watch out for, because they're the most severe. These typically occur when there are high levels of debt that have been accumulated in the economy and can often lead to a banking, a sovereign, or balance-of-payment crisis or a combination of those. And these recessions typically involve large declines in asset prices, significant damage to household and corporate balance sheets, prolonged periods of deleveraging and a slow recovery.
And that's often accompanied by deflationary pressures. So examples of this would include the Great Depression, which is the most famous one. It's a Japan in the 90s to a degree, the US during the GFC, and the Eurozone sovereign crisis are all examples of balance-shaped recessions. And I think understanding these types of recessions helps in framing potentially the growth outlook for the particular economy and understanding just the potential severity and duration.
And that also, of course, informs appropriate policy responses from government and policy makers. That's super helpful. And from talking to clients, I think that most people realize they can't forecast an event-driven recession. These are caused by exogenous shocks.
Income statement recessions, most credit investors seem like they are fairly constructive on the ability of corporate America to manage through that, especially as we haven't seen a lot of aggressive re-liverging in this cycle. It's that balance sheet recession that people are really focused on and trying to figure out what is the asset class that's going to be the tripwire. Private credits come up, CREs come up, and then, of course, a sovereign crisis with what we're seeing on developed market, fiscal deficits, people looking at France, people looking at Italy, people looking at the US and thinking, it does not seem like this is necessarily going to end well. That is for certain.
So what typically happens to some of the key macro variables during a recession? Well, we looked at the past 11 recessions to 1953 or so, and it's quite interesting because, as you'd expect, each recession is different, and the bigger recessions skew the averages, so you need to take the average number with a big pinch of salt. But I think one thing which is a bit more consistent is the fact that recessions on average last about eight to 10 months, although, of course, there are exceptions. On average, I would say, real GDP declines from about 2.8 percentage points from peak to trough.
So that's kind of just looking at the non-GDP growth, just the GDP level, real GDP level. But this figure is skewed by the GFC and the pandemic, which saw much larger decline. So if you were to remove those and only look at the milder recessions, then the decline from peak to trough is about 1.6 percentage point. So much, much lighter than it recovers after.
The other key variables to look at are unemployment and fiscal deficits. I think those are probably the most important from a policy-making perspective. So the unemployment rate on average rises about 4% points from trough to peak. But again, this is very much skewed by the pandemic, which saw something like 11% point rise as well as the GFC, which saw about a 5.5% point rise.
So if you exclude these two major recessions, then the average increases closer to about 3% point, maybe just below that. So not as aggressive, but still painful for households. And interestingly, from a fiscal perspective, I think things are getting worse, right? So the budget balance typically deteriorates about almost 5% points on average.
But again, that's skewed because of the pandemic, because of the 13% point or so of deterioration. Also the GFC was quite bad. But if you exclude the past two recessions, then the average is milder at about 2.5% point to 10% points of deterioration. But that's at a time where I think governments were more reluctant to run such white deficits and were more convinced that sound-money principles and more restrictive fiscal policy when needed was the right decision to make.
There's probably a little bit more political support for that on both sides. So I think when you look back to the 2000s or 1990s, 2000s, you actually do see slight widening in the fiscal deficit incrementally over each recession. And it just kind of chimes with the view that politicians nowadays, they're a bit less worried about the deficit for some reason. It is wild.
I feel like a bit less worried is the understatement of the century, for sure. Now, I mentioned earlier that a lot of the clients that we talk to have been saying that, all right, if there's a recession in the US, it's probably not going to be that bad, especially when we think about corporate balance sheets. Why does this seem to be the broad consensus? And are we all just eating too much Halloween candy?
Are we all geeked out on sugar and just seeing stars? Yeah, I think that's a fair point. I typically look a little bit more at the household sector as well as the corporate sector. I think broadly speaking, private sector balance sheets are stronger than they were before.
So remember, I told you that if you look at household debt in the US, it fell from about 100% of GDP to about 70%. So that's 30% points of GDP leveraging. It wasn't pretty deleveraging, but now basically US households are deleveraged. And that means that they're much better positioned to weather economic downturns.
I would also say that if you expect the Fed to cut in a recession, then that should provide timely support to the economy. And we think that the private sector would probably respond quite well to interest rate cuts, just because their balance sheets are better than they had before. And I'd also say that there's an absence of big, cyclical imbalances in the private sector. And that means that the private sector can respond much more quickly and much more positively to, let's say, interest rate cuts, tax cuts, or fiscal stimulus in the event of a recession.
So of course, I mentioned that household debt to GDP is lower, but household assets to liabilities is also much higher than before. So people are much wealthier in terms of they've been sitting on a decade or and a half of appreciation of their houses, for example. Stock markets are hitting record highs. So all of this is very good for a wealth effect.
And so households are very rich in assets. Of course, there's a skew across the demographics, but on a broad basis, I think households are pretty in good shape. That's it. I wouldn't note that given the wide fiscal deficits of around 6.5% of GDP in the US combined with already high levels of government debt and elevated bond deals that we've seen, I think there might be less room for significant fiscal response by the government in the event of a recession.
And that could potentially be one of the factors that may put downside, put a dampener on the pace of recovery from the private sector. So typically, the government provides a little bit support. If it's not able to provide that support, maybe the private sector doesn't feel as strong as it would normally. Given that this is a Halloween podcast, let's bring it back to something kind of spooky because you've been pretty constructive.
I appreciate the balance. It's nice to talk to someone who's not all doom and gloom. And that is the US balance sheet and fiscal deficit with higher treasury yields, government borrowing costs, and fiscal spending over the past few years. A lot of people are really focused on what's the trajectory of treasury rates?
What's the sustainability of the US budget? And everyone's viewing the problem as kind of this slow-moving train wreck. It's really hard to definitively draw a line in the sand for when the deficit matters to treasury markets and risk sentiment. In fact, I was talking to client today, and I was like, well, it could be the day after the election, especially if Moody's finally decides to downgrade the US from its AAA status.
Or it could be in 10 years, when we're in the end of the Social Security funds, and that's starting to run out. So somewhere between now and 10 years from now is apparently what it's going to matter, which is not at all helpful to clients. How are you thinking about the reality of an increasing fiscal deficit, almost irrespective of the election outcome? Because, like you said, Knight of Party is really all that big on fiscal consolidation at this point.
And are there scenarios that you're a bit more worried about? Yeah, my first instinct is that it's a political question, right? So the political divide is so wide in the US that each side, or it seems that each side can't afford to make the difficult choices that need to be made. I'm actually quite surprised that neither Trump or Harris have really talked about how they're going to narrow the deficit in a substantial way when in previous elections and previous cycles, they're so focused on the deficit, and they were nowhere near these levels, and the debt was nowhere near this level.
And historically, at least when governments can't make difficult decisions, that's when they kick the can down the road, and that's when the macro fundamentals start to get worse, and to your point, at some point, it grants, right? And you don't know if it's now or then, you know, this can push up long-term bond deals that could act as a break on growth, that could raise debt servicing costs. I'd be a little bit more worried, actually, in a situation where the economy falls into recession, and you get another widening of the deficit to about 10%, right? If you're at 6 and a half now, you add another 3% points or so, you're pretty close to 10%.
And I think bond markets might look at that and say, hmm, that's not pretty good. And I guess one thing which gives me a little bit, or which concerns me less, is the fact that central banks are much more independent than they used to be in the past, I think, and their policy framework is much more robust, institutional strength is more robust. And so I think where historically inflation has been a real problem or the fiscal debt has been a real problem was when the government forces the central bank to monetize the debt. And historically, that's Germany, for example.
We've seen other instances. That's when you get really worried. But I don't see that happening, for example. Central banks are super independent right now.
The other thing you have is markets, when they've had enough, they'll tell you, right? So market vigilantes could impose some discipline just as they did at eBay, but when Liz trusts announced her budget in the autumn of 2022, I believe. And so I think you're raising funds in the capital markets and capital markets are going to tell you something. Now, what's interesting as well is I've not only been surprised by US politics and global politics and the lack of willingness to narrow deficits, but I've also been surprised at how the markets are happy to absorb a lot of this debt.
So Japan's a great example, US, Eurozone, and even with higher interest rates, no one seems to be blinking. And so that from me is interesting. Or I don't have an answer to the question, but are we in a different regime? Maybe not.
Yeah, it's a great point because as much as we talk to clients about the big, bad bogeyman in the room of massive fiscal deficits of developed markets, nobody really seems to have a high conviction view on how to trade that or when the market is going to say no more. But Cedric, I know as soon as you figure that out, you're going to let me know, right? Of course, it might take a few years. Then it's my kid's problem.
Porcupidos. All right, Cedric, this has been a delight. It's always so fun chatting with you. I hope that everyone listening enjoyed.
If anyone has any follow up questions for me or Cedric, you can always reach out to me on the CreditSights.com website. And I will happily direct you to the BMI team, which is just a wealth of information covering all things across different industry risk and country risk. Thank you so much, Cedric, for joining today. Thanks, Lenny.
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