In short
When higher U.S. debt and higher Treasury yields start to matter for the economy and markets.
Guest backgrounds
Andrew Sheets, Global Head of Fixed Income Research at Morgan Stanley (no other guests mentioned).
Key claims
Despite rising federal debt (about $20T in first 240 years, another $20T in the last 10), U.S. economic activity hasn’t been significantly constrained; corporate debt share is broadly unchanged over the decade, household debt-to-GDP is lower than pre-COVID and even lower than in 2000, with mortgage debt locked at low rates and household assets at record levels. Stress is less visible in bond-market “markers” (inflation expectations stable, expected volatility historically low), and Treasury intervention surprised investors due to lack of usual stress signals.
Notable examples
U.S. bond yields vs inflation expectations (30-year Treasuries about 3% above expected inflation); long-dated U.S. investment-grade corporate bonds yielding over 6%; potential investor asset-allocation shift from equities to bonds not yet evident in fund flows/correlations; possible U.S. dollar weakening, especially vs Australia’s higher-yielding, lower-debt currency.
Written by AI. May contain mistakes. Listen to the episode to check what was said.
Chapters
Tap a time to open that second in VOThe Impact of Rising U.S. Debt on Economic Activity
0:18 to 2:48
Analysis of how increased U.S. debt affects economic activity and balance sheets.
“The country has borrowed another$20 trillion in just the last$10 trillion.”
Market Reactions to Higher Yields
2:48 to 3:52
Discussion on when higher yields may influence investor behavior and market allocations.
“Instead, the point at which these higher yields might have a larger market impact may be up to another factor, asset allocation.”
Transcript
Automatic transcript. May contain errors.0:00Andrew Sheets:Welcome to Thoughts on the Market. I'm Andrew Sheets, Global Head of Fixed Income Research at Morgan Stanley. Today, at what point do higher yields and higher debt actually matter? It's Wednesday, August 26th at 2 p.m. in London. In its first 240 years, the United States of America accumulated roughly$20 trillion in federal debt. The country has borrowed another$20 trillion in just the last$10 trillion. The question for investors is when this debt load will act as a break on economic activity, or worse, create stress that disrupts today's relative calm. So let's start with the first question. For economic activity, the bar seems pretty high.
0:48Andrew Sheets:You see, even with all the activity around AI, U.S. corporate debt as a share of the overall economy is broadly unchanged in the last decade and actually lower than where it was before the pandemic. The balance sheets of the household sector in the U.S. are even stronger. Household debt to GDP is lower than where it was prior to COVID and lower than where it was in the year 2000. And this may even understate the strength because much of this debt is locked in at historically low mortgage rates, while household assets, the other side of the balance sheet, have soared to record levels. That may help explain why both consumers and businesses have remained more resilient than expected this year, despite the higher interest rates and energy prices.
1:34Andrew Sheets:This divergence of trend between public and private balance sheets is also global. Europe has also seen higher government debt offset by even more private sector deleveraging, while Japan has seen rising public borrowing and pretty stable private sector leverage. To some degree, this divergence between the public and private sides of the economy reflects a policy choice. Governments determine how to balance taxation and spending, and many countries, not just the U.S., have reduced taxes over the last decade while allowing public borrowing to increase. A deterioration of public sector finances relative to private sector finances?
2:14Andrew Sheets:it's not especially surprising given that choice. If strong balance sheets are helping U.S. households and companies be less sensitive to higher rates, where should we look for stress? Well, for all of this debt, the U.S. bond market is actually still pretty well behaved. U.S. inflation expectations are roughly unchanged year to date. Expected bond market volatility is historically low. Indeed, one reason that recent intervention by the U.S. Treasury into the bond market was such a surprise to investors was the lack of these usual stress markers. Instead, the point at which these higher yields might have a larger market impact may be up to another factor, asset allocation.
2:57Andrew Sheets:Today, 30-year treasury bonds yield about 3 % more than expected inflation over that period. Long-dated U.S. investment-grade corporate bonds once again yield more than 6%. And so the question of when higher yields begin to matter may be less about when businesses stop borrowing or consumers stop spending, and be more about when investors decide that bonds offer better value than stocks. So far, Morgan Stanley research is not seeing clear evidence of that shift. Fund flow data and market correlations do not suggest a significant reallocation away from equities, and strong earnings growth is helping support the equity valuation case.
3:36Andrew Sheets:But these are metrics that we'll be watching. In the meantime, we think that rising U.S. debt and Treasury market intervention may weaken the U.S. dollar, especially against a high-yielding currency with much, much lower debt levels, the Australian dollar. Thank you, as always, for your time. If you find Thoughts of the Market useful, let us know by leaving a review wherever you listen, and also tell a friend or colleague about us today. The preceding content is informational only and based on information available when created. It is not an offer or solicitation, nor is it tax or legal advice.
4:11It does not consider your financial circumstances and objectives and may not be suitable for you.
From the publisher
Our Global Head of Fixed Income Research Andrew Sheets discusses when and how higher yields and mounting U.S. debt could become more than abstract concerns.
Read more insights from Morgan Stanley.
----- Transcript -----
Andrew Sheets: Welcome to Thoughts on the Market. I'm Andrew Sheets, Global Head of Fixed Income Research at Morgan Stanley.
Today, at what point do higher yields and higher debt actually matter?
It's Wednesday, August 26th at 2pm in London.
In its first 240 years, the United States of America accumulated roughly $20 trillion in federal debt. The country has borrowed another [$]20 trillion in just the last 10.
The question for investors is when this debt load will act as a brake on economic activity? Or, worse, create stress that disrupts today's relative calm?
So, let's start with the first question.
For economic activity, the bar seems pretty high. You see, even with all the activity around AI, U.S. corporate debt as a share of the overall economy is broadly unchanged in the last decade and actually lower than where it was before the pandemic.
The balance sheets of the household sector in the U.S. are even stronger. Household debt to GDP is lower than where it was prior to COVID and lower than where it was in the year 2000. And this may even understate the strength – because much of this debt is locked in at historically low mortgage rates; while household assets, the other side of the balance sheet, have soared to record levels.
That may help explain why both consumers and businesses have remained more resilient than expected this year despite the higher interest rates and energy prices.
This divergence of trend between public and private balance sheets is also global. Europe has also seen higher government debt offset by even more private sector de-leveraging, while Japan has seen rising public borrowing and pretty stable private sector leverage.
To some degree, this divergence between the public and private sides of the economy reflects a policy choice. Governments determine how to balance taxation and spending. And many countries, not just the U.S., have reduced taxes over the last decade while allowing public borrowing to increase.
A deterioration of public sector finances relative to private sector finances – it's not especially surprising given that choice.
If strong balance sheets are helping U.S. households and companies be less sensitive to higher rates, where should we look for stress?
Well, for all of this debt, the U.S. bond market is actually still pretty well-behaved. U.S. inflation expectations are roughly unchanged year to date. Expected bond market volatility is historically low.
Indeed, one reason that recent intervention by the U.S. Treasury into the bond market was such a surprise to investors was the lack of these usual stress markers. Instead, the point at which these higher yields might have a larger market impact may be up to another factor: asset allocation.
Today, 30-year Treasury bonds yield about 3 percent more than expected inflation over that period. Long-dated U.S. investment-grade corporate bonds once again yield more than 6 percent. And so, the question of when higher yields begin to matter may be less about when businesses stop borrowing or consumers stop spending. And be more about when investors decide that bonds offer better value than stocks.
So far, Morgan Stanley Research is not seeing clear evidence of that shift. Fund flow data and market correlations do not suggest a significant reallocation away from equities, and strong earnings growth is helping support the equity valuation case.
But these are metrics that we'll be watching. In the meantime, we think that rising U.S. debt and Treasury market intervention may weaken the U.S. dollar, especially against a high-yielding currency with much, much lower debt levels – the Australian dollar.
Thank you as always for your time. If you find Thoughts on the Market useful, let us know by leaving a review wherever you listen. And also tell a friend or colleague about us today.