US Debt Cannot Defy Fundamentals for Ever
US 10-year yields are low and despite a battle over raising the debt ceiling and a warning from rating agency S&P on the outlook for US debt, investors have yet to tire of the treasury market which has rallied since the end of April.
"This seems a clear indication that the market completely shrugs off the possibility of a hiccup in the short term, let alone over the medium in light of the adverse US fiscal position," Ousmène Jacques Mandeng from Ashmore Investment Management said in a research note.
"The US Federal Government has tripled the dollar amount of debt outstanding since 2000, the last time the federal budget was in surplus excluding social security,” he said.
While the federal government cannot go on borrowing beyond its means indefinitely, this does not mean Washington cannot go on issuing debt in the short to medium term.
The question is when investor sentiment and yields will turn.
"The combination of high levels of indebtedness, the scheduled end of the Fed’s policy of quantitative easing and increasing weariness by foreign central banks to increase their exposure to US government risk should eventually withdraw support," said Mandeng.
With more no change in borrowing expected until after next years election, Mandeng believes foreign central banks are likely to decide to keep buying US debt while attempting to "recalibrate their exposure".
Over time she is expecting yields to rise.
"The combination of reduced debt payment capacity (debt level), shaky payment willingness (Congress), limited domestic absorption capacity (households need to reduce debt) and tempered external demand (central banks buy less) should lead to lower prices of US government securities," Mandeng said. "The probability of a significant upward adjustment of treasury yields therefore seems the outcome most consistent with economic fundamentals."
"A continuation of QE (quantitative easing) may mitigate but cannot suspend those fundamentals. The market should be wary of not attempting to defy economic fundamentals for too long," said Mandeng.
Correction: An earlier version of this story said the author of the research note was a different person than Ousmène Jacques Mandeng from Ashmore Investment Management.