A world awash with debt
At the end of this week there will be important statistics to examine – the state of the labour market in the USA, and whether employment is rising so quickly that wage pressures start to worry the Federal Reserve.
Before then, bond markets remain in their summer doldrums in terms of pricing, but there is a sizeable amount of activity taking place in terms of buying and selling. A noticeable highlight was the successful issuance of new European Union bonds. These are associated with the €700 billion pandemic recovery package agreed last summer. The EU is creating a yield
curve across a series of bonds under its Next Generation EU programme. This week €170 billion euros of orders were placed by investors for its second sale, which was 10 times the available bonds on offer. Part of the attraction was the AAA rating, an exception in todayʼs markets, and a marginally positive yield, when the ECB keeps interest rates in negative territory.
The drivers of such bond issuance are, understandably, the extremely high budget deficits which governments are running at present. The situation was not good even before the hit from the pandemic, reducing tax revenues and spurring massive spending to support households and businesses. The US budget deficit grew to a record $2.1 trillion during the first eight months of this fiscal year. Discussions are ongoing about further spending, of course. President Biden and Congress have provisionally reached agreement on an infrastructure spending bill worth about another $1 trillion over the several years.
Indeed, the long-term outlook for public sector finances does not look good in the USA, or indeed most of the other major economies. On estimates from the Congressional Budget Office and Wall Street economists, the US will run a deficit of about 15% of GDP for two years but then settle down at annual deficits of about 5% a year thereafter. As the result, the Federal debt to GDP ratio, which in 2021 will exceed its previous 1946 high, will rise further through the 2020s. Even in Germany, the most hawkish of the European countries, there are no plans to reduce the fiscal stimulus before 2023 – and the outcome may well depend on the strength of the Green vote in the German elections later this year. As the Japanese economy suffers this summer from the covid lockdowns, there is speculation of a further package of easing measures into the autumn.
Analysis from bodies such as the OECD would argue that reforms of labour markets, business regulation, skills and training, infrastructure spending and such like should be the solutions to the secular stagnation which has acted as such a headwind to the major economies. However, governments understandably find it difficult to push through such complex reforms, and hence rely on easy monetary policy and loose fiscal policy to provide the necessary stimulus to the recovery.
Alongside the regular stream of government issues, it should not be forgotten that many companies, especially in the USA, are issuing large quantities of debt as well. Some finance officers are re-financing more expensive bonds issued several years ago. Others are building up their war chest to help finance the decent amount of M&A which is taking place, as stronger companies endeavour to take over weaker during this phase of the economic recovery.
The world looks to be awash with copious amounts of debt for years to come. There will be multiple buyers, of course. Pension schemes need to match liabilities. As equity markets rise so long-term investors will buy bonds in order to keep their long-term benchmarks intact. Retail investors are turning to corporate debt and infrastructure to provide the income which bank balances can no longer provide. Overseas investors will make cross-border purchases at a time when currency positions are relatively attractive.
Last but certainly not least, central banks will step in as and when required, of course. To give an example, between January 2020 and March 2021, eurozone governments issued a net €1.3 trillion in sovereign bonds. Over the same period, the ECBʼs net purchases of government debt under its various public sector purchase programmes amounted to 98% of that amount. Looking ahead it has the firepower to continue to do so during most of 2021. With such demand more than matching copious supply, it is no surprise that many investors feel reassured about buying bonds even at such low yields and expensive prices.
Andrew Milligan an independent Economist and Investment Consultant
Andrew Milligan an independent economist and investment consultant. From 2000-2020 he was the head of global strategy at Standard Life/Aberdeen Standard Investments, analyzing the major financial markets for global clients. He currently assists
a range of organizations with reviews of their investment processes, advice on
tactical investing and strategic asset allocation, and how to include ESG factors into their decision making.
Andrew Milligan is an independent economist and investment consultant. This note should be considered as general commentary on economic and financial matters and should not be considered as financial advice in any form.
Andrew Milligan an independent economist and investment consultant. From 2000-2020 he was the head of global strategy at Standard Life/Aberdeen Standard Investments, analyzing the major financial markets for global clients. He currently assists a range of organizations with reviews of their investment processes, advice on tactical investing and strategic asset allocation, and how to include ESG factors into their decision making