Would you lend to this man?

19/11/2018

Download

Andrew Mulliner, Portfolio Manager within the Global Bonds Team at Janus Henderson Investors, takes a candid look at escalating US debt and the implications for bond investors.

a

It’s all about lifting weights
We are not really talking about lending directly to Uncle Sam here, but the sheer size of the US economy (25% of world gross domestic product, GDP) and the history of the US dollar as a reserve currency means the US bond market is the largest and most liquid in the world. It also dominates bond indices, which by their rules-based construction are weighted to the most indebted nations.
 
When it comes to global bond indices, the heavyweight is the US and its influence is getting stronger at close to 40% of the global bond indices (see chart), while, combined, the US, Japan, Germany and France account for two-thirds of the total country exposure. As a global bond manager, this concentration is one reason why we believe the index is not the best starting point for portfolio construction given these benchmark biases.

Figure 1: Breakdown of the Bloomberg Barclays Multiverse, %
 1
Source:  Bloomberg  Barclays Multiverse Index, 31 October 2018
 
Debt explosion
The bad news is this could be getting worse as the US is going on a borrowing binge. With the US economy booming and official unemployment at just 3.7% – the lowest in almost 50 years and below the Congressional Budget Office’s estimates of the natural (or equilibrium) rate – one might expect some degree of fiscal responsibility, letting higher tax receipts boost revenues and building a buffer for the next downturn. In fact, the opposite is happening, with the tax cuts/spending programme likely to result in budget deficits of 5% of GDP in coming years (US$1 trillion in cash terms for 2019). Since World War II, the US has posted budget deficits that exceeded 5% of GDP in just two periods – 1983 and from 2009-12 post the financial crisis.
 
Moreover, the US corporate sector has also been issuing debt at low yields to buy back shares and add more leverage to the balance sheet. This elevates earnings in the good times but will have the exact opposite effect in a downturn. The US investment grade corporate bond market has grown from US$2trillion to US$6.3trillion in a decade, and average credit ratings have deteriorated with BBB-rated companies (the lowest rung on investment grade) now representing half of that universe.
 
Figure 2: Congressional Budget Office deficit projections, US$ billions
2
Source: CBO, baseline projections, April 2018
 
In the near term, this spending boost has helped fuel a short term "sugar rush", which we expect to fade in 2019 due to the combined impact of tighter monetary policy and the fading fiscal stimulus, as the US central bank continues to raise short-term interest rates.

Rollover risk
This cocktail of higher debt issuance and metronomic quarterly rate rises from the Fed, means the US Treasury will be refinancing more debt at higher interest rates. The average maturity of US government debt has been rising from its historic average of five years but it is still shorter than many other developed market peers. In practice, this means around two-thirds of outstanding treasury bonds will need to be refinanced in the next five years or so at much higher rates than before – around 3% based on current market levels, considerably higher than the average over the last decade.
 
Figure 3: Marketable debt outside the US Federal Reserve: maturity breakdown, % of GDP
US government debt is sensitive to higher short rates: most US government debt outstanding is <5 years maturity.
3
Source: Deutsche Bank Global Research, Treasury, BEA, Haver Analytics, October 2018
 
Higher yields must be good news for investors, right?
While the 3% yield available on US treasuries is the highest available since 2008 and is good news for US domestic savers, for overseas investors these higher yields are purely optical for those investing on a currency hedged basis. Higher short-term interest rates in the US are impacting hedging costs and depleting return potential for many non-US investors who invest in the US market. We anticipate foreign buyer demand to decline at a time when treasury supply will likely increase to compensate for government spending and a shortfall in tax revenues, a scenario that should pressure yields higher, all other things being equal.
 
Figure 4: Not much yield on a currency hedged basis, % yield after ccy. hedging
4
Source: Bloomberg, 31 October 2018
 
Some context needed
Given the dominance of the US dollar for the financial system, the US government bond market remains a safe haven in times of significant stress. However, in a rising rate environment where the Fed is continuing to reduce stimulus, the diversification benefit of owning US treasuries is weakened somewhat. As a result, we continue to favour geographies where central banks are neutral or on hold, such as Australia and New Zealand, longer-dated bonds in Europe where the yield curve is relatively steep, and also Canada where rate hikes are fully priced and a high level of private sector indebtedness is likely to cap longer-term rates.
 
While the rest of the world remains coupled to US markets, they respond with varying degrees. The Fed is normalising faster than the rest of the developed world, which will perpetuate the divergence in policy rates and likely present attractive opportunities in global government bond markets.
 

These are the views of the author at the time of publication and may differ from the views of other individuals/teams at Janus Henderson Investors. Any securities, funds, sectors and indices mentioned within this article do not constitute or form part of any offer or solicitation to buy or sell them.

Past performance is not a guide to future performance. The value of an investment and the income from it can fall as well as rise and you may not get back the amount originally invested.

The information in this article does not qualify as an investment recommendation.

For promotional purposes.


Important information

Please read the following important information regarding funds related to this article.

Janus Henderson Horizon Total Return Bond Fund

This document is intended solely for the use of professionals and is not for general public distribution.

The Janus Henderson Horizon Fund (the “Fund”) is a Luxembourg SICAV incorporated on 30 May 1985, managed by Henderson Management S.A. Any investment application will be made solely on the basis of the information contained in the Fund’s prospectus (including all relevant covering documents), which will contain investment restrictions. This document is intended as a summary only and potential investors must read the Fund’s prospectus and key investor information document before investing. A copy of the Fund’s prospectus and key investor information document can be obtained from Henderson Global Investors Limited in its capacity as Investment Manager and Distributor.

Issued in Europe by Janus Henderson Investors. Janus Henderson Investors is the name under which investment products and services are provided by Janus Capital International Limited (reg no. 3594615), Henderson Global Investors Limited (reg. no. 906355), Henderson Investment Funds Limited (reg. no. 2678531), AlphaGen Capital Limited (reg. no. 962757), Henderson Equity Partners Limited (reg. no.2606646), (each registered in England and Wales at 201 Bishopsgate, London EC2M 3AE and regulated by the Financial Conduct Authority) and Henderson Management S.A. (reg no. B22848 at 2 Rue de Bitbourg, L-1273, Luxembourg and regulated by the Commission de Surveillance du Secteur Financier). We may record telephone calls for our mutual protection, to improve customer service and for regulatory record keeping purposes.

Past performance is not a guide to future performance. The performance data does not take into account the commissions and costs incurred on the issue and redemption of units. The value of an investment and the income from it can fall as well as rise and you may not get back the amount originally invested. Tax assumptions and reliefs depend upon an investor’s particular circumstances and may change if those circumstances or the law change. If you invest through a third party provider you are advised to consult them directly as charges, performance and terms and conditions may differ materially.

Nothing in this document is intended to or should be construed as advice. This document is not a recommendation to sell or purchase any investment. It does not form part of any contract for the sale or purchase of any investment.

The Fund is a recognised collective investment scheme for the purpose of promotion into the United Kingdom. Potential investors in the United Kingdom are advised that all, or most, of the protections afforded by the United Kingdom regulatory system will not apply to an investment in the Fund and that compensation will not be available under the United Kingdom Financial Services Compensation Scheme.

Copies of the Fund’s prospectus and key investor information document are available in English, French, German, and Italian. Articles of incorporation, annual and semi-annual reports are available in English. Key Investor document is also available in Spanish. All of these documents can be obtained free of cost from the local offices of Janus Henderson Investors: 201 Bishopsgate, London, EC2M 3AE for UK, Swedish and Scandinavian investors; Via Dante 14, 20121 Milan, Italy, for Italian investors and Roemer Visscherstraat 43-45, 1054 EW Amsterdam, the Netherlands. for Dutch investors; and the Fund’s: Austrian Paying Agent Raiffeisen Bank International AG, Am Stadtpark 9, A-1030 Vienna; French Paying Agent BNP Paribas Securities Services, 3, rue d’Antin, F-75002 Paris; German Information Agent Marcard, Stein & Co, Ballindamm 36, 20095 Hamburg; Belgian Financial Service Provider CACEIS Belgium S.A., Avenue du Port 86 C b320, B-1000 Brussels; Spanish Representative Allfunds Bank S.A. Estafeta, 6 Complejo Plaza de la Fuente, La Moraleja, Alcobendas 28109 Madrid; Singapore Representative Janus Henderson Investors (Singapore) Limited, 138 Market Street, #34-03 / 04 CapitaGreen 048946; or Swiss Representative BNP Paribas Securities Services, Paris, succursale de Zurich, Selnaustrasse 16, 8002 Zurich who are also the Swiss Paying Agent. RBC Investor Services Trust Hong Kong Limited, a subsidiary of the joint venture UK holding company RBC Investor Services Limited, 51/F Central Plaza, 18 Harbour Road, Wanchai, Hong Kong, Tel: +852 2978 5656 is the Fund’s Representative in Hong Kong.

Information on this document is on Janus Henderson Investors’ best endeavours.

Specific risks

  • This fund is designed to be used only as one component in several in a diversified investment portfolio. Investors should consider carefully the proportion of their portfolio invested into this fund.
  • The Fund could lose money if a counterparty with which it trades becomes unwilling or unable to meet its obligations to the Fund.
  • The value of a bond or money market instrument may fall if the financial health of the issuer weakens, or the market believes it may weaken. This risk is greater the lower the credit quality of the bond.
  • Emerging markets are less established and more prone to political events than developed markets. This can mean both higher volatility and a greater risk of loss to the Fund than investing in more developed markets.
  • Changes in currency exchange rates may cause the value of your investment and any income from it to rise or fall.
  • If the Fund or a specific share class of the Fund seeks to reduce risks (such as exchange rate movements), the measures designed to do so may be ineffective, unavailable or detrimental.
  • When interest rates rise (or fall), the prices of different securities will be affected differently. In particular, bond values generally fall when interest rates rise. This risk is generally greater the longer the maturity of a bond investment.
  • Any security could become hard to value or to sell at a desired time and price, increasing the risk of investment losses.
  • Callable debt securities (securities whose issuers have the right to pay off the security’s principal before the maturity date), such as ABS or MBS, can be impacted from prepayment or extension of maturity. The value of your investment may fall as a result.

Risk rating

Share

Important message