by Benoit Anne, Managing Director – Investment Solutions Group, MFS Investment Management
Can US government bonds withstand the growing mountain of debt?
We have a fiscal problem in the US. At over 6% of GDP, there is no denying that the US deficit is abnormally large. Historically, similar fiscal gaps have only been observed during war time or as a policy response to a recession. The long-term average since 1969 for the US deficit in non-recession years stand at 3.5% of GDP, well below the current level. Unfortunately, there is little chance that the US authorities will pay attention to the fiscal issues in the near term, given the upcoming presidential election. Therefore, higher deficits are here to stay for now.
For now, the risk to markets from fiscal deficits appears limited. However, investors are growing concerned about the deterioration in the US’s fiscal position and Fiscal Deficits, Higher for Longer that could contribute to an upward correction in market rates. In other words, after the Fed’s policy action caused rates to rise substantially after March 2022, the fear is that the US Treasury may take over as a key upside risk for rates. While it is important to keep an eye on fiscal dynamics, we don’t believe that fiscal policy represents a major market risk, at least in the near term.
Also read: Where Can Investors Find Value In The Fixed Income Universe?
Do you see the huge US national debt as a real threat, or is it just a theoretical problem?
Excessive deficits pose many challenges. First, the larger deficit needs to be financed, putting pressure on the US Treasury to issue more debt. More importantly, a larger-than-desirable deficit means that room to maneuver is constrained, leaving policymakers with less ammunition in the event of a macro shock. Finally, strong fiscal stimulus at a time the economy is still doing well may cause it to overheat. Such an outcome could limit the Fed’s ability to normalize its policy stance after its recent aggressive tightening cycle.
Lack of fiscal discipline could constitute a major risk over the medium term. The relationship between fiscal policy and the market typically follows a tipping point—fiscal policy is not a major market issue until we reach a critical threshold. Over the short term, we don’t think that the fiscal policy challenges will push rates higher in 2024. Over the intermediate term, if not addressed, investors could shed US assets of all types.
Can US government bonds retain their role as an anchor of stability while the US debt burden continues to grow?
We do not see the role of US Treasury bonds as safe-haven assets being challenged in the period ahead. Only in an extreme scenario of a broad dollar-asset crisis would this situation be revisited.
How do you rate the attractiveness of US government bonds compared to those of other countries or regions, especially in light of a “higher for longer” environment that has now become more likely?
Government bonds generally are attractive in many markets, given the elevated yields by historical standards. Yields are higher in the US than in most markets, which means that the demand for US Treasuries is likely to remain robust. In terms of the potential for yields to go down—thereby helping the total return of fixed income—we see a stronger potential in the eurozone as we believe that the ECB will be more proactive with its easing cycle than the Fed. In other words, our duration conviction is higher in Europe.
