CBO: Lower '09 Gap But Long-Term Concerns

The U.S. budget deficit for 2009 was revised lower yesterday by the Obama administration and the Congressional Budget Office, though long-term deficits remain a concern as market participants said they could push Treasury yields higher and municipal yields with them.

CBO director Douglas W. Elmendorf said the projected $1.587 trillion deficit as a percentage of gross domestic product will be 11.2% in 2009, almost twice the previous record in the post-WWII era. But it was revised downward by $80 billion from the March projection, based on a projected $203 billion drop in the budget outlay for the Troubled Asset Relief Program, which was enacted last year.

The White House Office of Management and Budget reduced its deficit forecast to $1.580 trillion from the $1.841 trillion projected in May. But the OMB's deficit-to-GDP ratio remained unchanged from the 11.2% estimate it made it May.

The OMB removed a $250 billion placeholder for bank bailouts in the budget for the Federal Deposit Insurance Corp. that was released in February. Beyond 2009, the OMB's deficit projections were revised higher based on weakening economic conditions.

Speaking to reporters at a briefing yesterday, Elmendorf called the budget outlook "sobering" and "unsustainable," adding that the deficit could slow the economic recovery. He added that while the recession - which officially began in January 2008 - is "about over," the "recovery is likely to be slow."

The CBO estimated that the American Recovery and Reinvestment Act will cost about $115 billion in 2009, which includes the Build America Bonds program. A CBO official said the BAB estimate for the year - $53 billion - relies on the Congressional Joint Tax Committee's estimate from February. The official said the CBO is working to provide its own cost estimate of the BAB program. The OMB report does not mention BABs.

The OMB said unemployment is expected to peak at 10.0% in mid-2010 before declining. It said unemployment will reach 10.2% in 2010, up from its March estimate of 9.0% for the year.

The CBO expects real GDP to contract 2.5% in 2009 before expanding 1.7% in 2010. The estimate for 2010 was revised down from the 2.9% expansion that had been forecast for 2010 in March. The agency expects real GDP to contract 2.8% in 2009 before expanding 2.0% in 2010.

The CBO expects interest rates to rise in the coming years, though its estimates are in line with its previous projections from March. The three-month Treasury bill is expected to have an average yield of 0.2% in 2009 and 4.7% between 2014 and 2019. The 10-year note is expected to have an average yield of 3.3% yield in 2009 and 5.5% between 2014 and 2019.

The budget deficits, and the record amount of debt being issued to fund them, could weaken Treasury prices, causing yields to rise, market sources said. Though the correlation between municipal and Treasury yields has been upended since the credit crisis, market participants said higher Treasury yields could push muni yields higher.

If the deficits "reprice fixed-income to higher yields, muni [prices] at some point will probably fall," said Matt Fabian, managing director at Municipal Markets Adivsors. The higher yields for munis may mean BABs would be less attractive for issuers as the yield spread between BABs and municipals would rise, according to Fabian.

Meanwhile, Ben Bernanke, chairman of the Federal Resrve Board, was nominated by President Barack Obama for a second term. During the credit crisis, Bernanke joined Treasury officials in denying the municipal market access to most of the funding and backstop facilities set up by the Fed last year. Still, market participants supported Bernanke's nomination.

"It would have been difficult to remove him and put someone else in [his] place," said Chris Mier, managing director at Loop Capital Markets LLC in Chicago. "I think you want him in there to unwind the many things that he has done." The treatment of the muni market should be attributed more to the Treasury Department than the Fed, Mier said.

Bernanke's reappointment drew a cool response from some members of the Senate, which must confirm him for a second term. The Senate will need to consider "whether chairman Bernanke's performance as the chief regulator merits his reconfirmation," Richard C. Shelby, R-Ala., the ranking member on the Senate Banking Committee, said yesterday in a statement.

"We must determine whether chairman Bernanke has the strategic vision to chart the necessary course going forward and the resolve to stick to it, especially in light of today's announcement that the national debt is projected to exceed $23 trillion," he said.

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