Weekly Market Update: The US government’s poison pill

That public finances are so thoughtlessly sacrificed to keep 'the wrong crowd' out of office. It is the second consecutive government to do so.

And once again, as it has done so many times in history, the US is banking on the Dollar’s unrivalled status as a global reserve currency to keep demand for its debt high, especially now that the Fed is running down its balance sheet. This has of course propelled China and other countries to diversify away from the Dollar somewhat, pushing gold prices to the highest levels ever.

But the question for investors is: is it enough? Can the US stand such high On a not-so-separate subject, the economic miracle that is the US ploughs on. Against all odds, forecasts, projections and even its peers, the American economy persists in growing at a pace which allows for a strong labour market and, unavoidably, stickier inflation.

The business world watches, enthralled, at another strong set of employment numbers. 

As a result, the bond market tanked again (now -2.7% since the beginning of the year) and is pricing in less than three rate cuts for 2024 for the first time since October. The equity market, more captivated by the AI narrative than interest rates, persists on its own course.

But why is this? Why is the US defying all odds? And is this sustainable? The answer to the former is mostly clear.

Private and Public Debt.

The US average deficit since 1969 has been 3.2%. Yet in the years since the pandemic, the average deficit has been 8.2%, and has never really fallen below 4%. 

At this pace, the US is expected to run public debt at 131% of GDP by the end of the decade, and be forced to pay nearly double its annual growth in interest payments.

And it’s not just the state, it’s consumers too, racking up credit card debt at 30% interest. It should be no surprise that consumer delinquencies are rising at the fastest pace in years.

The US government seems resolved not to lose this election on account of the economy and doesn’t have the time to wait for inflation to drop to 2%. To put it differently, the difference between 2% and 3% inflation is less important than the difference between a recession and 2% growth, especially when you know that we have reached the sticky part of the inflation cycle.

It is perhaps a consequence of politics becoming so acerbic debt at higher yields and milder rate cuts (which means higher interest payments) from the Fed? Is the Dollar such an indefinite source of wealth that no matter how much one borrows, markets will always fund it?

History says no. There are limits.

A 'poison pill' strategy always leaves shareholders worse off. In a democracy, 'shareholders' are its citizens. Its creditors are other foreign states and banks. 

Investors are presently looking towards the bull equity market. But they should also look at the bond market which is having another bad year, as well as all the accruing debt. And in that consider whether this is the rally where one pulls all stops, or whether it is one where we should participate with a modicum of caution.

I’m borrowing from Ben Seager-Scott's (our new CIO) latest letter, which I think sums our position.

A significant factor in the ongoing optimism is the apparent strength and relative resilience of the global economy, especially in the US, coupled with inflation that continues to trend down towards the effective 2% target.

So far, so good, but there are two important counterpoints against joining the optimists from here. Firstly, valuations seem to have a lot of good news baked in and markets could be at risk of becoming complacent. Secondly, whilst inflation has indeed been coming down, we may be facing a bit of a last-mile problem getting from an inflation print starting with a 3 to prints starting with a 2. Indeed, short-term readings are suggesting the fall in inflation could be levelling off and as a result bond markets have been scaling back expectations for interest rate cuts for this year. We still see opportunities in markets and continue to maintain our current exposures, but are resisting the urge to lean any further into this potentially fragile rally.

At our latest quarterly investment committee meeting, we agreed to increase our exposure to government bonds with a more normalised duration – which means greater sensitivity to average expected interest rates over the next roughly ten years, rather than the next few years, as is the case with shorter-duration exposures. The yields on offer in this part of the market look attractive relative to the risks as we see them, and they can also be expected to provide some downside mitigation in portfolios if we do see economic growth shocks.

George Lagarias – Chief Economist

Markets had central bank policy on their minds last week, as global stocks declined by -1.1%. At the start of the week, good news was bad news for US stocks, as markets reacted negatively to a strong manufacturing PMI figure, but positively to a weak services PMI figure. US stocks then sold-off sharply on Thursday following several hawkish speeches from Federal Reserve officials. Finally, Friday’s jobs report led to a rebound in US stocks as job growth was much stronger than expected.

US stock returns were -1.0% over the week. Other developed markets also reacted to the Fed, as UK stocks fell by -0.5% and Japanese stocks fell by -2.7%.  

Yields on government bonds rose across the board. US Treasuries reacted differently to stocks in response to the jobs report; while stocks welcomed signs of a robust economy, bond traders saw the chance of rate cuts being further postponed. The US 10-year Treasury yield rose by 20.1 basis points to 4.402% as a result. The UK 10-year Gilt yield went up by 13.6 basis points to 4.069%, and the German 10-year Bund yield rose by 10.1 basis points to 2.399%.

Commodities did well over the week. Gold prices continued their rally, rising +4.4% as central banks load up on the precious metal. Oil prices advanced by +4.5% due to geopolitical tensions in the middle east.

Macro news

US non-farm payrolls rose by 303,000 in March, far exceeding consensus estimates of a 200,000 increase. The prior two months were also revised upwards, by a combined amount of 22,000. Strong job growth was seen in healthcare, government and construction. The unemployment rate fell to 3.8%, while the labour force participation rate increased slightly, showing that more people were able to join the workforce and find a job. The persistent strength of the US job market suggests that the odds that the Federal Reserve will delay its rate cuts are increased.

The US manufacturing PMI rose to 50.3 in March, marking the first month of expansion in the manufacturing sector in 16 months (figures above 50 indicate expansion). Strong readings were found in the new orders and production indices, showing that management executives have a positive outlook on the manufacturing sector going forward. The services PMI came in lower than expected at 51.4, from 52.6 in February, as a result of slower new orders growth.

The week ahead

Investors will be eagerly awaiting the US Inflation report, which is coming out on Wednesday. This number will be key in determining the Federal Reserve’s schedule for potential interest rate cuts. China will also report its inflation rate on Wednesday, while the UK will release GDP growth figures for the month of February.