Over three months, US 10-year rates fell from less than 4.0% to around 5.0%. At such a level, the cost of credit puts the economy and the financial system under strong pressure, worrying investors who wonder where the weak link will be.
Biden taxes little and spends even more
The recent spike in long rates in the United States may come as a surprise as the Federal Reserve has not raised its policy rates since July 26. Moreover, this increase was particularly well anticipated by investors and was not surprising. Let’s add that Jerome Powell and his colleagues are unsure whether they need to raise their key rates again. Then why the outbreak?
There is the fact that, after having long bet on key rates that would start to fall quickly, investors have finally taken seriously the Fed, which says that rates will remain high for a long time. This leads them to adapt to their expectations.
To this is added that, since the temporary disappearance of the debt ceiling in June, the White House spends without counting. In 2022, the US budget deficit was USD 996 billion. For 2023, income tax revenues are falling, spending is still rising, and the deficit will be about USD 2020 billion, more than double the previous year if the accounting treatment of the student loan moratorium is excluded.
However, this is not a record high, as the years of the pandemic have seen even more significant deficits. However, doubts about the management of public finances and the sustainability of the US debt trajectory are increasingly present. They are the leading cause of this surge in rates on the US bond.
If the debt supply is abundant, add that the demand of the Fed decreases as it shrinks its balance sheet, and some emerging countries reduce their US debt holdings, believing that their assets may not be honoured if Washington decides to do so.
An impact on the US economy
Naturally, the fact that the state finances and refinances at rates that approach or exceed 5% on all maturities - which means that debt charges continue to grow - is fraught with implications for the US economy. By financing itself increasingly at such interest rates, the American state relaunches credit for everyone.
The private sector suffers from the fixed rate on the 30-year mortgage, which serves as a benchmark for the US real estate market, having just exceeded 8%. Rates on personal loans exceed 11%. As for interest rates on credit cards, which were around 14.5% at the beginning of 2022, they have almost doubled since, currently exceeding 28%, and despite this, the share of this credit, easy but very expensive, in the credit mix is only increasing. The amounts borrowed by American households are at an all-time high, whether for consumption, buying cars or linked to a credit card.
Households are, therefore, caught in the throat, seen in their behaviour. Under normal conditions, such an expensive credit would result in real estate prices plummeting. That is not the case.
Households with a fixed rate signed a few years ago have no interest in parting with it. So they keep their property and refuse to move. The number of transactions is falling, and the construction sector is struggling because access to property is complicated. As long as the number of new homes on the market remains limited, prices will remain stable. However, any surge in supply could precipitate lower prices.
Elsewhere, late payments on auto loans are at a record high, and the worries of regional banks last spring remind investors that banks are accumulating significant losses on their bond portfolio. As long as they can keep these assets on their balance sheet, they will, and these losses will only be theoretical. But in urgent capital demand, they would be forced to sell these assets at a loss, which could weaken them, as was the case with SVB bank. This increases nervousness around the sector and pushes banks to tighten credit conditions.
Magnificent Seven and the Others: a world apart
This has an impact on the markets. The S&P 500 is still up 11% in 2023, driven by the magnificent seven companies in the US technology sector, with a global footprint, which nothing seems to stop, and easy access to credit.
But over the same period, the Russell 2000 index, which follows small companies more correlated with the US economy and which have increasing difficulties in financing themselves from banks, lost 5%. This performance gap speaks volumes about investors' enthusiasm for the stars of the US market.
While the S&P 500 is not cheap and offers a limited dividend of just 1.6%, its dynamism continues thanks to the United States' unsustainable ability to produce tomorrow’s champions. For decades, the US market has held the most oversized caps on the planet. He sometimes saw the arrival of challengers: Japan in the 1980s and China a decade ago. But each time, it has rebounded, retaining its supremacy, even if the names of the companies that made its success have changed, as have the most present sectors. So we continue to invest in it.
But at this point, the US stock market competes with the US bond market, whose yields approach or exceed 5% on all maturities. A yield guarantee will make investors think, especially since yield is not the only asset of US debt. If some announce (a little quickly, in our opinion) the decline of the US dollar, the fact is that it remains the reference currency for the whole planet. In the delicate economic situation we are going through, marked by conflicts of all kinds, the American debt remains a haven essential within a diversified portfolio.
We continue investing in U.S. equities and U.S. bonds as part of our diversified portfolio.