The great debt headache
Debt, debt, everywhere but not a drop to… add to any well balanced investment portfolio.
The world is awash with government bonds thanks to the debt piled up during the pandemic. But the increase in interest rates alongside the most significant bout of inflation for four decades has left investors in a quandary.
What interest rate is attractive enough to beat inflation in the long term and avoid losses in the event of even higher issuance?
The answer is almost certainly “higher”. The Moody’s downgrade of the US is a timely reminder of the risks to the growing pile of debt. Moody’s might be late in the game – Fitch moved to strip the US of its top rating in 2023 and S&P made their concerns clear back in 2011 – but it is coming at a more fragile moment for the US government.
US net debt and the deficit are larger now as a percentage of GDP than they were back then, just as the new President rips up the rulebook and attempts to rebalance the global financial system.
His gamble might pay off, delivering higher growth that can sustain all of the debt. If not, the President’s plans for even higher deficits through tax cuts might just make the problem even worse.
Rising sovereign debt (almost) everywhere you look
This is not just an issue for the leader of the US. Japan’s Prime Minister told his parliament this week that “we cannot agree with the idea of raising taxes and covering the resulting shortfall with government bonds… our country’s fiscal situation is undoubtedly extremely poor, worse than Greece’s”.
Greece might be somewhat aggrieved to be namechecked in this way, given they just printed a fiscal surplus which is allowing them to deliver a €1bn benefits package.
But the country has become synonymous with the concept of a sovereign debt crisis, having gone through one just over a decade ago. Political leaders know that it is toxic, if not existential, to preside over a debt-deficit spiral.
The UK had its own echo of this under the brief tenure of Truss and UK government bonds remain vulnerable despite Rachel Reeves’ best efforts to buttress the fiscal position. Her very first decision, to pay for public sector pay rises in part by cutting the winter fuel payment, has cost her party politically and failed to benefit the country economically.
Borrowing continues to rise, leaving the UK desperately hoping to attract bond investors in a sea of suitors. The US downgrade might diminish the appeal of US Treasuries but not necessarily to the benefit of gilts or Japanese government bonds. When risk rises for the deepest and most liquid market, denominated in the world’s reserve currency, it means the entire system has become more vulnerable to shocks.
Bond auctions were once the preserve of a niche group of specialist traders. They are now the signal for just how much debt issuance the world’s investors are happy to digest.
Helen Thomas is chief executive of Blonde Money