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There's no way to sugarcoat it: the US has a lot of debt.
Expect to start feeling the effects of the national deficit in the fixed income market soon, according to Charles Curry, senior portfolio manager of US fixed income for the asset management firm Xponance. As spending increases, the government has to borrow more money, resulting in a higher supply of Treasurys coming onto the market which end up lifting interest rates.
US national debt hit an all-time high of $35 trillion this July, just months after passing $34 trillion in January.
And it's only going to get worse. Regardless of who wins the election this November, Curry doesn't think the issue of the national debt will be addressed.
Reducing the national debt will require increased taxes and reduced spending, both of which are very unpopular policies. Given the hyperpolarized political environment, Curry doesn't see a possibility of Washington enacting the sweeping policy necessary to get the national debt under control.
"I don't see any will by any policymakers to cut it," Curry said. "Everything they're trying to fund is going to cost more. The biggest elephant in the room is military, Social Security, things of that nature."
Additionally, with demographic shifts like an aging population, demand for Social Security spending will only increase.
As the US government continues to accumulate more debt, investors should expect more Treasurys to hit the market and the yield curve to normalize, Curry predicts.
Roughly 17% of the ICE BofA Treasury index, which tracks the performance of US government securities, will come to maturity in the next two years. That's roughly $2.9 trillion that the US government will need to refinance. Thanks to the last few years of near-zero interest rates, coupon rates on Treasury bonds are lower than the yield on the Treasury index. This means that market interest rates are higher than those on existing debt. As a result, the debt will need to be refinanced at a higher rate.
Subsequently, interest payments on the national debt will continue to rise. Curry is concerned that a higher interest rate burden will create a crowding out effect where interest payments on debt eat into the budget for other essential government expenditures.
There's also the question of who will buy US debt. Elevated debt levels could weaken the dollar and decrease investor confidence in the US economy. Investors who do invest in US government debt will demand more compensation for the additional risk they're taking on.
New Treasurys hitting the market and increased interest payments on debt will cause the yield curve to steepen, Curry said. The yield curve has been inverted since 2022, meaning that short-term debt has returned more than long-term.
"The curve should probably un-invert and steepen because we have a voracious appetite for debt. More debt is coming," Curry said. "And at some point, there's got to be a marginal buyer of that debt."
As the Fed cuts rates and the government issues more debt, securities with longer maturities will have higher yields to entice investors to buy, according to Curry.
Curry has the following suggestions for fixed income investors as the rising national debt injects more turbulence into markets,
He recommends positioning fixed income portfolios in the belly of the Treasury and corporate spread curves, aiming to stay within five to 10 years of duration. This allows investors to benefit from higher yields currently but minimize their exposure to the longest-duration bonds, which stand to rise and therefore lose value. Right now, the spread between 10-year and 30-year bonds is relatively flat, which means that investors aren't getting much extra compensation for investing in bonds with much longer time horizons, so Curry doesn't see much benefit from going very far up the yield curve.
Curry also emphasizes investing in quality fixed income. For those investing in corporate debt, be mindful of the sectors you're investing in and look for solid business models and financials. Curry warns investors against investing in credit within cyclical sectors, as those securities will be volatile in the current macroeconomic backdrop.
Asset-backed securities are another attractive area of fixed income, according to Curry. This category tends to be more defensive and provides a good source of income.
"You're getting your income, but it's backed by things like data storage, storage centers, fiber deals, things that have real assets and collateral behind them," Curry said.
They also have a relatively short average lifespan of three to five years, which allows investors to play the middle of the yield curve.
