- Macro Strategist
- About Us
- My Account
The views expressed are those of the author at the time of writing. Other teams may hold different views and make different investment decisions. The value of your investment may become worth more or less than at the time of original investment. While any third-party data used is considered reliable, its accuracy is not guaranteed. For professional, institutional, or accredited investors only.
The recent downgrade of US debt by Fitch raises a number of important questions about the health of the nation’s finances and the policy and market implications. In this brief note, I summarize my views on the US debt situation, including the bond market impact, projections for the US deficit, and key considerations related to the US Federal Reserve’s (Fed’s) plans.
Red flags for the debt level and the deficit — My primary concern on the US debt has to do with the level of debt, which is currently at 123% of GDP. Anything over 100% warrants attention. Plus, the US is running a meaningful fiscal deficit (year to date, it sits at 5% of GDP). Some evidence of this is visible in the behavior of longer-term yields. The yield on the 30-year US Treasury is now above swap rates after being below them in the 1990s, a period when US fiscal deficits were in relatively good shape.
Looking ahead, many deficit projections assume that the Trump tax cuts will expire at the end of 2025, leading to a boost in tax revenues. But this seems optimistic given the country’s current political climate. A simple rule of thumb is that the country’s debt can remain sustainable if interest rates stay below the economy’s nominal growth rate. In the second quarter, US nominal growth was at an annualized rate of about 4.7%, so if rates were to rise above that level, it would bear watching.
Bond yields and the term premium — The recent upward move in bond yields has been driven in part by supply-related factors, including high issuance by the US Treasury, the impact of the Fitch downgrade, and worries about who will buy all these bonds — as Japan eases up on yield curve control and the Fed talks about reducing its Treasury holdings through more quantitative tightening (QT).
The term premium on Treasury bonds (the additional yield investors require as compensation for holding longer-term bonds) should rise over time, given the problematic US fiscal outlook and the unwinding of quantitative easing (QE). The term premium used to fall in a range of 0% – 2% prior to the global financial crisis. It turned negative with the introduction of QE, but I expect it to return to positive territory.
The Fed’s balancing act — Since last year, the Fed has reduced its ownership of domestic securities by US$1 trillion through its QT program. Fed Chair Powell recently indicated the central bank would like to continue QT even when it starts to cut interest rates. No guidance was given, but we could potentially see another US$1 trillion – US$1.5 trillion of QT from here. Cumulatively, that could amount to an increase of 50 bps – 75 bps in longer-term yields. With the Fed wishing to keep optionality on rates alive, the yield curve is steepening, with the long end catching up to the short end as the term premium gets priced back into the curve.
A Fed that wants to stay higher for longer in order to bring down core inflation risks adding to the fiscal pressure and creating instability for the US sovereign market. It’s worth noting that higher real yields also pressure equity valuations and imply lower earnings growth in the future.
Somewhat paradoxically, the Fed is seeing more tightening now, as yields rise, than it did earlier in the year in response to its own tightening efforts. This means the Fed has more room to give ground on short rates if it chooses to. I don’t think we’re there yet, but my base case is that we’ll seen more evenhanded policy from the Fed toward year end (unless something bad happens).
Finally, I’ll be watching the Fed’s Jackson Hole meeting at the end of August for signs of a surprise in its thinking on inflation, QT, and rates. This year’s meeting topic — structural shifts in the global economy — opens the door to considering issues such as the impact of shifting demographics, the energy transition, and supply chains on inflation, growth, and employment.
The intersection of geopolitics and deglobalizationContinue reading
Macro implications of the AI revolution: is the market right?Continue reading
Commodities: Top ideas and evolving opportunitiesContinue reading
Look below the surface: A contrarian view on China equitiesContinue reading
Monthly Market Snapshot – October 2023Continue reading
Have the Fed’s recent comments just provided a tailwind for agency MBS?Continue reading
Securitized debt: Strategies for navigating emerging cracks in consumers’ financial healthContinue reading
The intersection of geopolitics and deglobalization
The geopolitical landscape is likely to remain complex and unpredictable throughout 2024. What are the key risks to watch out for and what are the implications for investors?
Macro implications of the AI revolution: is the market right?
Macro Strategist John Butler sets out an initial framework to help answer key questions about the potential macro impact of artificial intelligence.
Commodities: Top ideas and evolving opportunities
To help clients plan for the coming year, our commodities experts share their top near-term, medium-term, and long-term investment ideas.
Look below the surface: A contrarian view on China equities
Equity expert, Ben Chen, dives into China's murky investment landscape.
Monthly Market Snapshot – October 2023
A monthly update on equity, fixed income, currency, and commodity markets.
Have the Fed’s recent comments just provided a tailwind for agency MBS?
Fixed Income Portfolio Manager Brij Khurana explains why the market may be missing an important nuance in the Fed's focus on financial conditions.
Securitized debt: Strategies for navigating emerging cracks in consumers’ financial health
Our expert highlights reasons for deteriorating consumer financial health and explores strategies for mitigating risk in securitized asset-backed securities.
The future of investment research
Head of Investment Research Mary Pryshlak joins host Thomas Mucha to discuss the evolution of research in the asset management industry amid shifting market, technological, and geopolitical environments.
The great central bank balancing act
Marco Giordano examines the difficult balancing act that central banks around the world are seeking to perform and its likely implications for investors.
You snooze, you may lose: The case for bonds
There are signs the Federal Reserve's rate-hiking cycle may be nearing an end, but some uncertainty remains. With that in mind, Multi-Asset Strategist Nanette Abuhoff Jacobson considers the timing of a move from cash to bonds.
EMEA Investment Forum 2023: highlights
In this short video we share highlights from Wellington's 2023 EMEA Investment Forum, "The only constant is change" and explore associated expert insights.