As the Times Square clock was ticking down to the end of the 1980’s, another clock, newly installed a mile away on the corner of Sixth Avenue and 42nd Street shone into light, its 306 bulbs illuminating passers-by that the US national debt was nearing $3tn. Several locations and new digits later, according to the Congressional Budget Office, the US national debt ‘clock’ in the hands of the public is creeping over $26tn. The overall level of debt spiked during the Global Financial Crisis and again during the pandemic, but regardless of whichever President has been in power, the US government has been running a structural deficit every year since the early 2000’s. The US budget is challenged by the same issues faced by many countries, such as an ageing population and the increasing costs of healthcare provision, with both social security and healthcare programmes expected to broadly double in costs in the next ten years. Alongside that, extra pressure on the deficit came from President Trump’s 2017 Tax Cuts & Jobs Act during his first term, as well as the millions of pandemic-related stimulus cheques that went to US households. Another big pressure point on the deficit has been from the rising net interest costs of funding the debt burden, as US government borrowing costs rose from its 2020 pandemic low of 0.32% to 4.2% at the time of writing.
Who’s the Patsy?
Whilst foreigners remain the biggest owners of US Treasury debt, the appetite for adding more has weakened, particularly from China over recent years, leaving Japan as the biggest overseas holder. There are geopolitical headwinds between China and the US with increasing trade friction being a bi-partisan unifier, but appetite from China may also be quieter due to the fallout from the war in Ukraine and the concerted action that sought to reduce Russian access to the global financial system. Over in Japan, the potential for more interest rate rises from the Bank of Japan could tempt some of those benefitting from the carry trade to become more restrained, but that ‘could’ should probably be italicised, whilst the difference in interest rates between the US and Japan remains as sizeable as it is.
In the meantime, the Federal Reserve continues to shrink its own holdings of US Treasuries and mortgage-backed securities at a rate of $95 billion per month. During the coming months, it is likely that we will hear more from the Fed on this process and the plan of action to reduce and then stop the amount of its balance sheet reduction. Maintaining it at the same time as trying to stimulate the economy with interest rate cuts, would be akin to giving with one hand, and taking from the other.
Instead, the recent buyers of US debt have been households and investment funds attracted by the higher interest rate being offered on the world’s ‘risk-free asset’, in much the same way as they have been attracted to cash. Commercial banks are also bigger holders than they have been historically, certainly when comparing to pre-financial crisis times.
Unlike in the UK when Prime Minister Lizz Truss’ disastrous 45-day tenure witnessed the attempt to push through unfunded tax cuts that caused the markets both incredulity and alarm, the US government is extended far more generosity by virtue of it being the world’s reserve currency. There may, at least for now, be no patsy.
So, should investors be showing US Treasuries the red card?
Not now, but never say never.
For our part, we have been happy to add US government bonds to portfolios. An attractive yield, whilst assuming no corporate credit risk and hedging the currency, speaks to us as an opportunity to capture that yield whilst also holding an asset that investors tend to flock to in periods of elevated geopolitical risk. Having said that, there’s a risk that a second term of a potential Trump Presidency could see more attempts to deliver further unfunded tax cuts, above and beyond an extension of those already anticipated. There’s always a limit, but with US Treasury yields towards the top of their twenty-year range, and the pathway clearly flagged to a central bank policy that will become more of a tailwind than a headwind, US Treasuries look attractive on several levels.
