The US Bond Market: Navigating Geopolitics, Fiscal Factors and Diversification

We're talking about an interesting topic today because we're going to talk about something which might seem very strange to those of us living in South Africa , you know , at the tip of the continent and we're going to be focusing on the US bond market , the American bond market , and I can claim very confidently almost zero knowledge about the US bond market .

So I'm going to have to bring in an expert , and I'm very glad to have Anton Azer he's the Chief Investment Officer at 10X Investments to talk about this . Thanks so much for joining us again , anton .

We sit here in the tip of Africa in a tiny little continent , worrying about mining and elections and politicians , and then the media are blabbing on about the US bond market . What on earth has that got to do with this ?

Us treasury market is kind of perceived as the place to go to , which is what they call the risk-free asset . So if you don't want to own any risk , you know the dollar as a currency is perceived as the base currency for every single currency that trades in the world .

Everything trades relative to the dollar , commodities are priced in dollars and so the reserve currency , as it's called , is perceived as the dollar . And if you want to own the dollar , you can really do that in the most risk-free way by owning US treasury bonds . So you know the treasury bond .

Really my whole career , you know from the 90s or goes , dates back in terms of how important this has been . But the treasury bond market has been always perceived as what's called the risk-free asset . So you know , if you're very scared about owning risk , you sell all of your risky assets like equities and you go and buy treasuries and really everything .

So if you think about a company which is issuing debt to fund their operations in the US . They come along to the market , issue some bonds and they issue at a spread relative to treasury bonds .

So if you are a highly rated corporate issuer , like , let's say , apple , you come to the treasury market and you issue that at , let's say , 101% over treasury bonds and then you lock in your coupon .

So everything right through from , like you know , corporate bonds which are directly linked right through to how we think about , let's say , the value in equities , you know what is the yield I'm earning on my risk-free and what is the earnings yield I'm earning on equities as a reference point through to Treasuries and so on and so on .

So you know , when we think about risk , think about everything that we look at in financial markets , it always comes back to this concept of the risk-free , and that is going to be a really important topic for our discussion today . Is it still the risk-free ?

And especially , you know global stock markets , and in the US in particular , you would use the US and I'm guessing it would apply . The same principle would apply , for example , if you're looking at , you know , outside of the US , if you're saying , well , gee , I like , for some crazy reason , I think France is the place to go .

Now , I think you know that's an economy that's going to be booming . You know your alternative to France would then be well , what's the risk-free rate ? And that would be US Treasury . So it gives you that absolute kind of zero level , from which you then say am I prepared to take more risk than the risk-free rate ?

And if I am , how am I going to be paid for it ? So , whether you're buying shares in emerging markets , or bonds in emerging markets , or property or anything , if you're a global investor , your benchmark would then be am I paid for any more risk than just going into those US treasuries ? If I'm understanding it correctly .

For as long as I've been in the markets which sounds almost as long as you , Anton it's always been the dollar and there's always been someone punting an alternative , whether it's the euro then it was , then it was going to be China and then for a little while , it was going to be cryptos .

It always sounds to me like people are looking at an alternative and predicting the death of the dollar as the reserve currency and the death of US treasuries . Are we still having that debate ? Is it still ? Is there a viable alternative ?

And I think that debate's going to continue for a while and I think , look , it gets complicated . There's a lot of geopolitics around this . You know China , russia , as we know , and then you mentioned crypto . Back in the 70s , 80s , 90s , it was gold and you know these themes are going to , I think , going to continue .

They've been debated for decades and will continue . I think what is what has definitely been changing , definitely since the financial crisis and , in particular , I think , in the last three years , which has brought this whole debate really much more to the kind of center of things in terms of financial markets and where we are , is just around two things .

It's firstly around just how big the global debt to GDP and , in particular , this focus on the US , how big US debt to GDP has become , and since COVID , you know that number just really went gangbusters . You know the days of any fiscal discipline in the US are long gone and the number just ratchets up . The deficit just gets higher and higher .

And then there's this second one , which is around what's called monetization of the debt . This is around the Federal Reserve and their quantitative easing policies and just how much debt is sitting and owned by the central banks . You know , in the US , same in Europe . Obviously , japan's a massive owner of their own government debt .

And so this kind of whole thing around the sustainability of the dollar , the sustainability of the treasury markets , look , it's very difficult to predict , but every year that kind of question around sustainability is just getting more and more questioned . And you know , as we know , with all these things in financial markets , you can never predict .

You can prepare , and to predict ultimately when that does shift and change is very it's impossible , it's impossible to do . Financial markets ultimately will determine the direction of this . But yeah , I think it's a really important point for all of us and I do think a lot of things in the last little while have been changing .

And you know , I think a lot of times when people debate this whole issue around debt it's quite a mixed view . A lot of people say , well , for every liability there's an asset . So why do we care about debt ? Because debt ultimately is offset by assets and the US is a very asset-rich economy and all these bits and pieces . So look at Japan .

Japan's debt to GDP is like it . It's like 240% and it's been growing every year since 1990 . And if you've kind of had a view around it being a problem , you've been completely wrong for three decades . So you know , why do we care now ? I think that really is the crucial point . Why do we care now ? I'm sure we'll unpack that .

You know almost no interest rates and you know just carrying on . And stock markets you know kind of only really very recently , you know , breached its high from , I think , the late 80s , if I'm not mistaken , or early 90s .

And so you sit in an environment where you know , talking about predictions , you know you could comfortably predict that if you live in a place with very low interest rates , that that would cause people to spend more and that would become inflationary and that would be a problem for an economy .

And , as you say , if you'd had that view on Japan in the middle of the 1990s , you would have been horribly wrong for a very , very long period of time , wrong for a very , very long period of time . And so it is important to know that . You know financial kind of principles do apply , but sometimes they don't apply for a long period of time .

And I'm looking at the US and I'm thinking to myself I mean not to be flippant about it , but it is a country which is kind of addicted to debt and you know it's seemingly .

You know , if I talk to some of my kind of more pessimistic investor friends they would say well , america's kind of due to run out of money , you know , somewhere around the next nine or 11 years because they won't be able to afford to repay all the debt , just the interest that they're accumulating on their debt all the time .

And you know that's again , that's a prediction . That probably tells you more about the person making the prediction than about the future . But I sit here on , you know , thinking to myself it's probably going to become a belief or sentiment issue .

You know that at some point outside investors , maybe even American investors themselves , will look at the American government and American economy and say we think we're at the point now where this government and this country can't afford to repay its debt . And it will be a sentiment point rather than an absolute financial calculation .

And if the question is being asked more and more and more frequently and by more people , then it tells you that sentiment is starting to shift and I think that's the danger sign for the US bond market . It's probably not a specific pure financial measure .

I don't know if you remember , back in 2010 , 2011 , there was a really well-known book written called this Time it's Different by Reinhardt and Rogoff , two very well regarded economists , and they did a whole bunch of work to your point around at what point does debt to GDP become a problem , and they did a whole bunch of financial modeling and it's a very good

book . I mean well , if you enjoy economics , it's a very good book . But the reality is that a lot of those calculations have become kind of redundant because , you know , here we are in levels of 100 , 120% debt to GDP and it hasn't been that relevant . And I think this goes ultimately to your point around sentiment At what point does sentiment become an issue ?

I think , saying that , however , there is something around the maths which is super important and if you look at a country like South Africa , where our debt to GDP is somewhere around 75% , whereas the US is 120 , japan is 240 , yet there's no issues around debt sustainability in the US and Japan in terms of perspective , whereas there is one in terms of perspective

in terms of South Africa , and obviously the big difference is South Africa we're funding our debt at around 10 to 12% , in Japan it's somewhere around 0 to 1 , and the the US is now around 4% to 5% . So it goes back to this point that we were talking about . The math actually becomes super relevant when your interest costs and your refinance rate goes up .

That's just the way it is . I mean , in the end , debt only becomes a problem when the percentage of your revenue if you're a corporate or an individual which you're paying towards your interests becomes disproportionate and you no longer can finance your lifestyle or the economy or your company . And that breaking point is actually around the mass .

And from a South African perspective , we're kind of very close to that point . And the US is really reaching a point now where their interest expenses as a percentage of their fiscal deficit is just ratcheting up significantly every single year . That interest rates remain at this level .

And the irony around interest rates remaining here and remaining high for a while is it means that they have to refinance at a higher rate and refinance more and more of their debt for a longer portion of the time at a higher rate .

So if you had a spike in interest rates and then all of a sudden interest rates went back down , well it's kind of irrelevant , because you've only refinanced maybe 5% of your debt outstanding . But if you have a spike and then we continue in that level , let's say for three or four years , you end up refinancing 30% , 40% , 50% .

You lock in that high level of interest and that's basically what we're going through at the moment . You know , we're kind of two years now into this interest rate cycle . The interest cost that the US is paying is going up . As long as we remain this high , then that rate's going to continue .

So you know , this whole thing which changed post-COVID was the size that it was for the first time we've had . Well , since the 70s and 80s we've had inflation , proper inflation , and for the first time , fed through with with the government , through kind of coordinated policy , effectively created inflation . They , they helicopter money .

They effectively went and injected money into people's bank accounts and that created I mean , there were a number of factors , but effectively that was the main factor around the inflation that was created . And so you know , beforehand they could print as many dollars as they wanted to , they didn't really care because in the end it never created inflation .

Japan never created inflation . The US fed , you know , qe1 , qe2 , qe3 . Covid came along Bang big fiscal deficits , huge QE program and we had this huge inflation problem , and that essentially changed the rules of the game around printing money and effectively creating this kind of buffer for the bond market .

And we're now sitting at this very strange point in this whereby inflation is still quite sticky , rates are quite high and the government is refinancing at a much higher rate .

And that's ultimately why right now , compared to any point in the last 15 years , the ratcheting up of the size of the debt , the stickiness of inflation and the high level of interest costs that need to be paid now from the government's perspective , those two things are kind of coming together right now and we're not really seeing that in terms of any panic in

bond markets . I mean , you know the bond market had that kind of initial big sell-off in 2022 , kind of stuck around that level of , you know , three and a half to four to five percent or so in 10-year treasuries , and we're staying at this level right now , and you know to say where we go from here .

I mean , that's ultimately , I think , exactly to your point . It's exactly around sentiment and it's exactly around this whole thing around definite geopolitics , and politics is going to be important for that .

You know you've got to start , you know , resizing your budget . Spend a bit less .

You know if you can't increase your revenue anymore , then what you can do is you can control your costs and reduce your costs so that you can pay down your debt faster , and that you know that would be very simple advice to give a human , and certainly you know the right advice to give the Americans .

You know there's the American government to stop spending so much , you know , and stop wasting your money on things that are not good for your economy .

But we all know that the US operates in a very dysfunctional system where you know anything that someone wearing a red tie a Republican , says will be immediately counted by someone wearing a blue tie who's a Democrat , and so they're in an environment where it would almost be political suicide for them to stop spending , you know , to reduce their spending .

Voters won't vote for that .

And so it's an interesting situation where you've got , you know , the American governments all of them , you know happy to spend , and I mean , we're not going to try and give a political prediction , but I'd love to know what your thoughts are on , you know , if we're sitting in December 2024 with President Trump , what does he do in a situation like this ?

And though that tax bill which was passed expires next year , the first thing he'll do alongside you know , the Republicans in the House and the Senate is you'll get the tax bills , get the tax bill extended so you'll keep corporate tax rates incredibly low . Will you cut them more ? That's going to be very difficult , but anything's possible .

So I think what you can expect is a you know , what you can expect is a continuing policy around kind of very loose fiscal policy coming out of the US in terms of maintaining that deficit at kind of 7% .

I think the bit which is different because I mean , biden's done that for the last three years anyway , so we haven't got somebody on the other side who is being fiscally disciplined the big , the potentially difference , the difference here with the Trump versus Biden is much more around the geopolitics than the domestic politics .

From a debt perspective , I think the debt perspective between Trump and Biden is probably similar-ish . It's around . It's really around the geopolitics and we've obviously seen Biden start to talk around tariffs and he's done a few recently , you know , around renewables , which was quite ironic .

But Trump is a different level of protectionism and you know that kind of geopolitical situation .

It's relevant for many reasons inflation , all these bits and pieces but it's very relevant in terms of this whole point we're discussing around the dollar and China has traditionally held a significant amount of treasury , bonds and dollar-based assets , you know , and that's been a big part of the way they've managed their currency and that's been a big part of the way

they've managed their currency . But a geopolitical situation we suddenly see China reduce their dollar holdings it really brings into tension a financial system which is heavily dependent on the dollar as a reserve currency .

If we continue to see fragmentation in terms of trade , in terms of geopolitical issues between the US and China , then this whole kind of financial system around the dollar being the reserve currency , treasuries being the risk-free asset , it starts to continue . It just escalates the risk around the fragility of that system being maintained as the status quo .

So I think that's probably more the difference around Trump versus Biden than it is around , domestic fiscal policy being massively different . Both of them , both parties , are going to go be , as you know , fiscally expansionary , as they have been and they've proven now for a long time really .

It's the most attractive it's been in 15 , 20 years and definitely relative to equities it's very attractive . So the valuations in the treasury market are very attractive .

On a historic basis and in the environment whereby we have a global recession and a drop in inflation , the demand for treasury bonds is going to be holding on our sconce is going to be very high and therefore bonds are actually a very attractive asset class .

So you've got this kind of like anchor over here which is saying own me , because bond yields are very attractive . On the other side , what we talked about today is that you have this huge fiscal sustainability issue which is coming out of the US .

You have a lot of geopolitical situations , liquidity issues which we haven't really gone into , a lot of reasons why actually the US bond market has kind of reached this new point whereby there's just so much supply and there's so many questions around sustainability . Does actually that swamp everything else ?

And in that environment , obviously , if there's lots of supply , not too much demand , then yields go up . And I don't want to complicate it for your listeners , but it's really important that we understand that these are two very different environments and ultimately the decision needs to be made around which of those two is going to be the highest probability .

So the way to kind of and it's very hard to do that because in the end it's all around sentiment and forecasting and predicting is very difficult , I would say , and definitely just in terms of how we positioned .

Maybe that's a way to kind of answer the question , because in the end , you can say all these things and it's what do you actually own that matters the question , because in the end , you can say all these things and it's what , what do you actually own that matters ? Um , we do own a lot of dollar cash . You know cash yields are very attractive .

Um and um , you know , you , you , you don't have any volatility through , through movements in , in , in yields , so so , so cash , um is actually the only diversifying asset class , apart from things like gold . So we do own a lot of dollar cash . We are actually in the end of the view that it's more the risks around .

We're very late cycle in the global economy and hence a slowdown in growth and a drop in inflation is a more likely scenario and therefore owning duration in our bond portfolio is what we do . So we are actually overweight duration .

So actually , despite everything I said , you know , in the end the anchor , which is around low levels of inflation , is more of a pull than what we've discussed here today .

What we've discussed here today , but overall and I will say this , kind of the risks and we spoke last time on your podcast around valuations in the US equity market and the risks here around debt sustainability in the US really tells you that overall owning risk is something which you know .

This is the time to be defensive in all of your multi-asset portfolios by owning cash and bonds and just being very careful and prudent globally in terms of your multi-asset portfolios , by owning cash and bonds and just being very careful and prudent globally in terms of the equity allocation . And that's how we position .

So we underweight US equities , overweight US cash and just marginally long US bonds . For investors , you can , gold is a very good tail hedge against this scenario . It's been doing relatively well but there's a lot more potentially in there for gold . That's obviously good for South Africa given the amount of gold exposure we have .

But there are asset classes which can kind of provide that type of a hedge that I mentioned , you know , against the scenario I mentioned before . Like gold , but simplistically , you know , overweight cash , kind of marginally long bonds and underweight equities .

You know in the detail and eventually you've got to make some decisions and ultimately , you know , proper diversification counts a lot , you know , and not being too brave in terms of just chasing growth for growth's sake , I think , is important .

You know , if you're watching the big tech companies pumping out great results and if you believe that you allocate all your money to tech companies only , you might be setting yourself up to fail . You know .

So kind of de-risking some of your portfolio and being a little bit cautious , a little bit conservative when the world's so uncertain and unstable is not necessarily a bad decision . And don't worry too much about FOMO . This isn't a sprint , it's a very long marathon and I think proper diversification is a real key in an investment cycle like this .

So , antonejo , thanks so much for joining us and we look forward to chatting to you again .