April 23, 2018
America Is Going Even Deeper Into Debt
How much debt can the U.S. government afford? Nobody knows for sure, but it’s pushing the envelope like never before — or at least more than it has since World War II. In its latest Global Fiscal Monitor report, the International Monetary Fund offers an admonishment for the world’s developed nations: Use this period of economic growth to pay down some of your debt. Pretty much all are aiming to make some progress, with one notable exception: America. Thanks to the tax cuts and spending plans Congress has passed under President Donald Trump, the U.S. government’s debt 1 is now projected to reach 96.2 percent of gross domestic product by 2028. That’s seven percentage points higher than the Congressional Budget Office’s 10-year projection from a year ago, and almost as high as in 1946, when the government had been borrowing heavily to build tanks and planes for the war. So how much is too much? As the world’s largest economy and the issuer of its dominant reserve currency, the U.S. gets more leeway than other nations. Its government bonds are considered the ultimate safe asset, at a time when such assets are in great demand. When crises hit, investors flock to the haven of the dollar, driving down U.S. borrowing costs. As a result, the government hasn’t been punished for over-borrowing to the extent that others have. As long as interest rates remain low, the U.S. can stabilize its debt burden with relative ease. The math is simple: The ratio of debt to gross domestic product will stay the same if the numerator (debt) grows at the same rate as the denominator (the economy). In the long term, the U.S. economy is expected to grow at a nominal rate of about 4 percent. And the debt — if nobody actively adds to it — will grow at the rate of interest, currently forecast to be a bit less than 4 percent.
Dollar Strengthens as U.S. Treasury Yields Near 3%: Markets Wrap
The dollar rallied at the start of a week packed with catalysts, from economic data to new debt supply, as the yield on benchmark U.S. Treasuries climbed toward 3 percent. European stocks edged lower after equities across Asia retreated. The yield on the U.S. 10-year note hit 2.99 for the first time since 2014 as investors continued to weigh the outlook for international trade and growth. S&P 500 Index futures drifted as the Stoxx Europe 600 Index slipped and the MSCI Asia Pacific Index dropped. The pound joined major currencies retreating against the greenback as U.K. Prime Minister Theresa May battled to avert a cabinet revolt over Brexit. The euro also weakened on signs the European economy remains in low gear. As tension over trade between the U.S. and China appears to ebb — Treasury Secretary Steve Mnuchin said he’s “cautiously optimistic” on reaching an agreement — and North Korea pledges to dial back its nuclear ambitions, traders could be forgiven for breathing a sigh of relief. But they must now come to terms with a deepening government bond selloff that has implications for everything from company borrowing costs and the strength of the dollar to investor allocations. “Ultimately it’s hard to see a move sustained above 3 percent on the U.S. 10-year,” Mitul Kotecha, a strategist at TD Securities, told Bloomberg TV from Singapore. “Some of the dialing down in tensions, in risk aversion, may be having some impact there as well as expectations of continued strong growth in the U.S.”
U.K. Set for ‘Uninspiring’ Growth After Weak Start to 2018
The U.K. economy shows little sign of breaking out of its “pattern of uninspiring growth,” and the first quarter may have been weaker than expected. The first three months of the year may have seen gross domestic product gain as little as 0.2 percent as severe weather cramped growth, a report by the EY Item Club will say Monday. That’s below the 0.3 percent estimate of economists before the initial reading of the data, which will be published Friday. It also downgraded its annual forecast to 1.6 percent, from 1.7 percent previously. While the Item Club expects two Bank of England interest-rate increases this year and a further two in 2019, it said there remains uncertainty around the outlook for policy. Governor Mark Carney on Thursday pushed back against the high expectations for tightening at the May 10 meeting, pointing out that there are other opportunities. “Raising interest rates this year is not an open and shut case,” said Howard Archer, chief economic adviser to the EY ITEM Club. “With inflation heading down and the Bank of England’s view of the supply-side of the economy arguably too pessimistic, two rate hikes this year risk exerting unnecessary pressure on consumers.” The report said that while households should see a “double positive” for real-income growth from weakening inflation and rising pay, spending will still slow this year. It’s a bleaker picture for exporters too, as they lose the competitive advantage afforded by the pound’s slump following the 2016 Brexit vote and protectionism weighs on global growth.
China Yield Slide May Pose Greatest Danger to Emerging Markets
While rising U.S. bond yields have triggered equity-investor anxiety around the world this year, when it comes to emerging markets, it’s the slide in China’s yields that may be posing the greater danger. Yields on 10-year Chinese government bonds have been a strong indicator of earnings-per-share for emerging-market companies over the last five years, and the recent decline suggests a deteriorating outlook, Morgan Stanley strategists including Graham Secker and Jonathan Garner wrote in a note to clients Friday. “What makes the move more disconcerting is that there has been a very close correlation between China yields and the global economic surprise index over the last year,” the strategists wrote. “This raises the question as to whether China is the potential source of slowing economic momentum through the global economy.” The concern showcases the increasing importance of China as a lodestar for developing economies, compared with the U.S. For decades, a key concern for emerging markets was how they would cope with rising American interest rates, and the shifts in capital flows that often accompanied them. Now, it’s a softening in China that could pose the key risk. China’s 10-year government bond yields have retreated to their lowest in almost a year, after the central bank’s unexpected move last week to ease funding pressure among lenders by cutting their reserve requirements. Even before that, the yields were coming down amid forecasts for China’s financial deleveraging initiative to damp growth this year
As Investors Dump Japan ETFs, Jefferies Sees Room for Optimism
Investors in Japan’s exchange-traded funds are finally saying uncle — but don’t count out the nation’s stocks just yet. ETFs in the country saw $4.39 billion in outflows for the week of April 12 to 18, the first time since last December the asset class saw such an exodus, according to EPFR data compiled by Jefferies Hong Kong. During that 19-week streak, Japanese ETFs had seen $47.5 billion in inflows. “Japan saw the most significant withdrawals in recent history,” Jefferies strategists Tommy Tang and Kenneth Chan said in an April 23 note. “Switching away from the U.S. benefited Japan — a phenomenon frequently observed over the past quarter but this saw a turnaround last week.” Yet the latest reversal isn’t necessarily a bearish warning sign for sentiment. Analyzing four- and 13-week returns of the MSCI Japan Index in dollar terms after the 10 biggest withdrawals since 2010, the strategists found the gauge actually posted a positive average return overall and gains in six out of the 10 instances. The latest rebound may already be coming, with foreign investors pumping in about $2.3 billion into Japan stocks in the three weeks through April 13, while the benchmark Topix Index is currently on track for its first monthly gain since January. Easing geopolitical tensions in recent weeks have cooled the yen’s ascent against the dollar, boosting corporate profit sentiment.