The skyrocketing interest rate environment where fixed deposit promotional interest rates in Singapore have crept up beyond 3% for some banks is unheard of.
The last time the fixed deposit interest rate went up above 3% was in 1998. Savers and property owners on mortgages have been used to a low-interest rate environment for a long time.
With any hints of a crisis, the central banks have been very proactive in their quantitative easing policies that have flooded the financial markets with excessive liquidity.
That has led to euphoric bubbles with most now being tamed. The surprising element was inflation was accommodative during this period as it just nudge nicely along.
However, what changed the overall game plan in recent times was inflation is turning into a beast with the US latest figures hitting above 8%. The parallel scenario would be the 1970s period when the overall economy was in a stagflation mode- High inflation but low growth.
They only managed to finally curb the inflationary pressures when the US central bank go all out by increasing the interest rates to 20% in 1980. The current Federal Interest Rate is at 3.25% with the expectation of it reaching 4% in the near term.
Not taking into consideration the recent ultra-low interest rate environment over the past decade, the normal sweet spot for interest rates would be around 2%-5% region. Therefore, if you look at it, we are just back to a normalised situation.
| US Debt | Current Yield |
| 2 Yr | 4.35% |
| 10 Yr | 4% |
| 30 Yr | 3.95% |
Source: Investing.com- US Treasuries Yield
Given the backdrop, it is no surprise that US Treasuries are looking attractive with 2 Years Bills giving a yield of 4.35%.
Giving some perspective, a decent corporate bond in Singapore in the pedigree of AllGreen and Straits Trading is currently giving a yield of 4%-4.5% and has an expiry date of close to 3 years.
The latest Singapore Treasury Bill auction in October for 1-year yields 3.7%.
Are US Treasuries A Screaming Buy?
We are not sure if the US would repeat their 1980s feat of increasing interest rates to astronomical levels- 20%. So to safeguard this scenario, the choice would be to buy the lowest duration of the US Treasuries offerings- ie: the 2-Year Treasuries.Â
This would mitigate the effect of unrealized capital loss as a lower duration bond would have the least impact on increasing interest rates since it is expiring soon. Therefore, that would be our choice investment if we are to invest in the US Treasuries.
3 Main Factors Affecting Fed Decision
The three main factors affecting Fed Interest Rate Decisions are GDP growth, Unemployment Rate and Inflation Rate. At this juncture, the latest GDP growth for Q2 was negative 0.6% (US is now in a technical recession as the previous quarter also saw a decline of 1.6%), the unemployment rate is at 3.5%, and the Inflation rate is standing at 8.7%.Â
The target inflation rate is at 2% and so there is still massive room for reversion to the target inflation rate. Unemployment is acceptable with the full employment rate definition at 5% and the current unemployment rate falls within the definition. The only worrying part of the equation will be GDP growth which is sluggish that would lead to a more measured increase in interest rate by the Fed.
Historically, when the inflation rate reaches double digits, the Fed would be aggressive even given sluggish GDP growth. We are not at that stage yet but an increase to the higher end of the sweet spot of 5% is very likely in the near term. This would bring the inflation rate back to a more manageable level. A change in the target rate to 4% would be plausible so a more drastic increase by Fed would not be necessary.
Further Pointers to Take Note
US Debt Level
Source: Tradingeconomics.com- US Total Debt
The US debt level is at its all-time high of 31 trillion dollars. Thankfully, they did not commit to the Ukraine and Russian War. There have not been any concrete plans to reduce this debt load.
Source: ceidata.com- US Government Debt to GDP
The US Government Debt to GDP is 135% which puts them in a precarious situation as a figure above 90% is usually a red flag. Giving some perspective, Japan is at 266% (Most debts are owned by Locals) and China is at 66%.
However, China’s private debt is a cause of concern even though its sovereign debt is likely under control- Total debt to GDP is close to 300%.
Source: Federal Reserve Economic Data- US Budget Data to 2019
Source: Peter G Foundation- US Deficit from 2017-2022
The US has also been in a budget deficit situation for the longest time ever which makes us wonder if they are able to reduce their debt by the normal conventional way rather than through the printing press method.
Looking at the above charts, their deficit has been steadily on the uprise and only during Bill Clinton’s reign did they manage to register a surplus over 4 decades.
Fed Balance Sheet
Source: fred.stlouisfed.org- Fed Balance Sheet
The Fed Balance Sheet has also been scaling new highs. The Fed usually purchase treasury bills in the market and places them under their balance sheet, which could reduce the interest rate as they create demand for treasuries during the monetary easing period.
Given that the US is now doing monetary tightening to fight inflation, the balance sheet should decrease as they would be selling treasuries from their balance sheet to the market.
Ironically, the Fed’s Balance sheet is still hovering around the 9 trillion dollars mark despite a more attractive yield. Could it be they are having difficulties finding whales- big buyers- for their inventory?
China Holdings in Treasuries
Source: ceidata.com- China Holdings of US Treasuries
It is also noteworthy that China has reduced their treasuries holdings to below 1 trillion in recent times despite a more attractive yield. It is currently at 970 billion dollars, the last time China’s US Treasuries is below 1 trillion was in 2010. Japan which is the biggest holder of US Treasuries has also reduced their holdings to 1.2 trillion.
Will US be in a Sovereign Debt Situation?
Given the facts presented, it comes to the inference a sovereign debt crisis could possibly unfold. It is not only in the US but Europe and Japan when the domino effect comes into play. It is hard to fathom that confidence in US Treasuries could be shattered as it is the risk-free asset that most investors would flock to in times of crisis.
Ways US can Get out of Trouble
Inflate their Way Out
The easiest way would be to inflate their way out of trouble is by using the printing press but this strategy would undermine their credibility. Unlike Argentina where their debts are in foreign currencies, the debt is in US Dollars where they could just print money and repay their obligations.
The implication would be the treasuries would be worth less relatively as, ” Too Much US Dollars to Chase Too Few Goods“. Therefore, it will exacerbate the inflationary problem. There is no need for the US to devalue their currencies as unlike the UK in 1992 (George Soros got famous from this trade), they are not pegged to a basket of currencies.
Pledge of Fiscal Prudence
Another approach would be to turn the budget deficit into a surplus which we think is a tall order for the US based on its track record. Moreover, to go through austerity measures would be tough and do not do good for an election. More importantly, we are looking at a massive debt that even if they are to run a budget surplus (assuming a trillion a year), it could possibly take a decade or more to bring the US debt to a more reasonable amount.
Learning from Russia (Back to Bretton Woods)
When the confidence of the US dollar or fiat money shatter, the only way to bring credibility and faith back would be to pledge the currency to a physical asset such as gold or even silver.
We could see from the dramatic recovery of the Russian rouble after the launch of the Ukraine War where they were hit with sanctions.
Their counter move was two-fold; Peg the roubles to gold and more importantly; For natural gas purchases, it has to be in roubles.
This immediately created a stabilising effect on their currency as demand for their natural gas is a necessity.
For the US, it could be back to the Bretton Wood days when the US was pegged to gold and it was unpegged in 1971.
However, the US dollar remains strong as all the oil contracts have to be traded in US dollars from an agreement in 1945 with Saudi Arabia that spread to other Arab nations. This is what was termed as “Petrodollar“.
Also, the US have the biggest shale oil reserve in the world, which could replicate Russia’s play of only payment in US dollars for their shale oil.
Summing Up
Having gotten used to US Treasuries rate at below 2% for the longest time, 2 yr treasury yield of 4.3% is indeed enticing.Â
However, we do have reservations about a potential sovereign debt crisis that would lead to even the safest asset in the world being unsafe. No doubt, we do not feel there is going to be a default but our relative value in the US Treasuries could devalue if they choose the printing press to get out of trouble.
Even China and Japan are reducing their US Treasuries holdings and selling them at losses given interest rate has gone up. Logically, it should be even more attractive to put in more funds now given a higher yield. So it could be their inference of things to come which is likely to be negative.
Moreover, interest rates are likely to go up further as long as inflation does not come down to at least below 5%, therefore what is attractive could get even more attractive.
In the meantime, we would stick to bonds that are denominated in Singapore Dollars as we feel more confident about the sovereign risk of the Singapore government. 1 year Singapore Treasury is at 3.7% whereas shorter duration good name corporate bonds are yielding around 4%-4.5%.
Disclaimer:
The content here is for informational purposes only and should NOT be taken as legal, business, tax, or investment advice. It does NOT constitute an offer or solicitation to purchase any investment or a recommendation to buy or sell a security. The content is not directed to any investor or potential investor and may not be used to evaluate or make any investment. Do note that this is not financial advice. If you are in doubt as to the action you should take, please consult your stockbroker or financial advisor.
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