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Just a shorter note this week ahead of the UK bank holiday weekend. Last week I wrote about government debt. Times are good, yet G7 governments are still running the large deficits that ballooned out after Covid. And in the US at least, it is hard to see the political will to make a change. The Republicans, traditionally the party of fiscal conservatism, are now the problem.
I want to follow up on three things I wrote last week. First, I said the trillions (yes trillions) of dollars being spent on AI infrastructure is adding to the borrowing pressure and keeping interest rates higher. I still think you can see this effect in the investment grade credit markets where nearly all of the borrowing is being done. But this week, Robin Brooks (formerly of the IMF and Goldman Sachs) was out with a note saying, basically, I am wrong.
His evidence is the slightly messy chart below. It shows net saving for different parts of the economy and the blue represents the corporate sector. You can see that US companies are still net savers today. This is in stark contrast to the 2000s dotcom boom and bust where you can see it went negative to finance that fibre roll out. So, governments are the real problem today and government debt markets are where you should expect to (continue) to see the strains
And before we get too bearish, the pink here represents households. They became net borrowers briefly in the 2000s which, via mortgage debt, ended up triggering the financial crisis. Households – and I am including IPS clients in this I hope! – remain in good health and I would guess this cushion is a major reason why the US (and UK) economies have proved pretty resilient to the shocks thrown at them in recent years.
Second, I wrote last week that I remain (stubbornly) optimistic that the longer-term path for inflation is down not up. UK inflation came in last week at 2.9% year on year, still within 1% of the longer-term 2% target. A big part of the current overshoot is oil and energy. And, barring another escalation in the Middle East, this is expected to fall next year as this year’s increase washes through:
Finally, I wrote that if, as happened last week, the US tries to intervene in bond markets to push yields lower, the release valve is often the currency. But before you say “go short the USD” remember that the UK and much of Europe is ultimately in a similar position. I therefore mentioned Emerging Market debt as a potential diversifier. This has one obvious drawback in that it is traditionally risky, so probably won’t be much help in a crisis.
I am not sure why I forget to mention another obvious hedge last week, but I did. And that would be gold. If you worry about today’s debt dynamics, then gold feels like the right hedge to me. It has also started to rise again, with a catalyst being last week’s US bond market interventions:
For those having a bank holiday, I hope you get to enjoy the last of the summer. Otherwise, see you again in September.
