Transcripción

Amanda Agati:  

How is it November already and time for the next edition of "#AddingAlpha"? 

I've been on the road visiting clients pretty much all fall so far, and the number-one question I'm getting asked is not about who is going to win the election, or even what my 2025 song of the year is likely to be, though I have started working on it, and I'm definitely taking requests, so that's your call to action. But instead, it's what's our view on the federal deficit and debt levels.

Is it ever going to matter for markets or investors? I'm sure many of you are familiar with the saying "Deficits don't matter," and for decades, that has pretty much proven to be true, at least when it comes to observable market-moving implications.

After all, we haven't had a balanced budget since early 2002, and yet the S&P 500 is up an annualized 9.6% since then. The U.S. federal budget deficit as a percentage of nominal GDP stands at negative 7.2% presently.

Believe it or not, over the past 40 years, the federal deficit has averaged just about 52% of where we are currently. While there's no doubt we are in uncharted territory by this measure, we've spent well beyond levels that are typically associated with economic recessions or an economy that is just emerging from recession, and, in our view, that has certainly helped to extend the current business cycle.

Enter the equity and fixed-income markets and two opposing points of view on the path forward. I always liken the equity markets to behaving like my nine-year-old in a candy store, craving the sugar high for more stimulus and policy accommodation --in this case, in the form of deficit spending.

Just like my nine-year-old, the equity market doesn't really know what's good for it and certainly doesn't know its own consumption limitations. Just like the sugar rush from eating all that trick-or-treating candy on Halloween night commonly ends in a sugar tantrum and tears, the same thinking applies to the equity market, except maybe it doesn't end in tears so much as it ends in a volatility tantrum, and I can't get no satisfaction.

As much as it pains me to say this, because I am an equities girl at heart, I think the fixed-income market feels like the sanity check on this topic right now because, for the first time maybe ever, we're starting to see the impact from the federal deficit and debt levels show up in market-based interest rates.

Believe it or not, ever since the Fed cut its policy rate by 50 basis points in September, long-term interest rates have moved higher, to the tune of about 60 basis points on the 10-year treasury.

This is the fixed-income market signaling, "Houston, we have a problem." We're seeing it in inflation-based expectations, too. 

The five-year break-even yield has also jumped about 40 basis points in September and is now at the highest level since early June. Therein lies the risk, though. Excessive borrowing typically leads to inflationary pressures, which typically leads to higher interest rates. It's a vicious cycle of rinse and repeat without an easy policy off-ramp.

When we look at the shape of the yield curve, it is incredibly flat from 10 years out to 30 years. We think the deficit and cost of debt service are translating into an anchoring of higher long-term interest rates.

As the Fed continues to cut rates, that should help to alleviate some pressure on the cost of debt service and eventually steepen at least part of the yield curve. But until then, we don't believe
investors are getting paid to materially extend duration.

All the action is in the belly of the curve for short to intermediate durations and investment grade credits. Now is just not the time to go long.

This topic isn't one that's going to go away anytime soon, as markets will be confronted with the debt ceiling debate in early 2025. The debt ceiling has been suspended since junio de 2023, and it's scheduled to end on 1ro de enero de 2025.

So the good news is that liquidity injection will make equity markets happy. But the bad news is it's likely to create more volatility in fixed-income markets.

A tale of two markets, to be sure, and a bit of a quandary for multi-asset investors.