Should asset owners worry about US debt-to-GPD forecasts?
The Congressional Budget Office expects US debt to GDP to rise to 120 per cent from its current 101 per cent ratio by 2036. (Logan Voss/Unsplash)
The scale of the United States’ $39tn debt can be metaphorised in one numeric reality: that the interest the US pays year-to-year on its debt ($1tn) is larger than its annual military budget ($916bn).
Given current federal policy and spending, this ratio is not expected to improve. The Congressional Budget Office now expects debt to GDP to rise to 120 per cent from 101 per cent ratio by 2036.
The impact of the ratio on long-term US economic health remains a less settled issue. Some asset owners have voiced concern about mounting and unchecked US debt and its impact on yields, inflation, the viability of US government bonds and the long-term influence and reliability of the dollar.
“The telltale signs are in the yield curve. You’d see a downward revision in the pricing of the debt,” according to David Krakauer, vice president of portfolio management at Mercer Advisors.
Krakauer said a key indicator of asset owner sentiment will be whether buyers are purchasing bonds with 30-year durations, adding that long-money buyers purchasing elsewhere will foray a real and significant issue within US bond markets.
Brian Neale, chief investment officer at the $2.3bn University of Nebraska Foundation, expressed concern surrounding longer-duration bonds.
“I might not buy a 30-year [treasury yield] but I might buy a five-or-10,” he said.
Investors express particular concern about debt-to-GDP from the perspective of US politics. As Krakauer puts it, in “Congress choosing not to pay the debt” in light of mounting political polarisation.
“The biggest challenge is our own political system. No one wants to raise taxes, no one wants to cut spending,” Krakauer says, alluding to a common tension between fiscal probity and retail politics.
Max Osbon, owner and managing partner of Osbon Capital Management, a $200mn Boston-based multi-family office, points to a similar issue.
“We’re not going to ever try to pay down the debt because our political system will never support that action on either side of the aisle,” he says, referring to the Democrats’ aversion to cutting spending and Republicans’ to raising taxes.
Neale, meanwhile, said this was a challenge of democratic governance. “China positions itself for the next 100 years. The US is focused on the next election cycle,” he says.
He adds that there are consequences to lacking a sound fiscal or budgetary policy on the federal level.
“After the [2008] financial crisis, we started seeing debt issuance get out of hand… [And] for the foreseeable future this government is going to print money. Can you just keep printing money forever?” he asked. “At one point does the dollar lose its status as the de facto world currency?”
Still, investors question to extent to which a high or increasing debt-to-GDP ratio is a problem.
“What we’re not seeing,” says Krakauer, who lives and works in the US, “is people not buying our debt, and certainly not boycotting our debt”.
According to Krakauer, a main reason for this is that despite the size of the government’s interest payments, “the US continues to pay its debt, with no sign that it’s stopping”.
He also, along with Osbon, questions whether debt-to-GDP is an essential or relevant indicator of long-term market health, adding that it is risky to treat it - or even government debt more broadly - like it were “household debt”.
“Those are not fair comparisons,” he says.
“There is no perfect ratio,” Krakauer concludes. “There is no formula that says a one-to-one ratio is too high or low… We care that the rest of the world has faith in the United States so that they buy our debt. We care that we can actually book our business responsibly.”
Osbon proposes a different metric: “Debt to GDP ratio is overhyped and at its root level doesn’t really make sense. Debt to assets, or debt to income makes more sense.”
Asset owners also questioned whether US debt levels pose a serious challenge to its economic dominance. Despite concerns, Krakauer and Neale are both sceptical of the idea that China in particular is a viable contender to US status as global economic hegemon.
Neale also cites the looming reality of US military dominance. “The United States has 11 aircraft carriers,” he says. In comparison China has three currently - though it harbours ambitions to reach nine within the next decade.
Still, a number of asset owners agree on the importance of diversification, a buffer against what Krakauer termed “idiosyncratic risk”.
As an example, “within the US bond allocation, you don’t just want treasuries; you also want [corporate fixed income]”, he says.
Mathew Jensen, senior investment officer of the $296.6mn Unitarian Universalist Association of Congregations Endowment Fund, says the religious endowment approaches fixed income with a policy of “[pairing] a diversified passive treasury and Treasury Inflation-Protected Securities allocation with highly active management”, as a means of offsetting reliance on any single asset type or style.
Jensen also says the association is “evaluating whether a modest increase in allocation to real assets could further strengthen the portfolio's long-term inflation resilience.”