The US administration has reportedly reached a deal with the Congress majority leader to enhance the debt ceiling on the treasury and mitigate yet another default threat. This, like all previous episodes of default threats and debt ceiling hikes, would inevitably result in more debt, insolent fiscal profligacy and further distortions in capital allocation and unsustainable asset price inflation. At the other end of the spectrum, it could shift a couple of ounces from the weight of global confidence in USD (and hence UST) towards the still nascent movement to de-dollarize global trade.
In this context, the following trends may be pertinent to note, especially for the equity investors.
Negative divergence in OECD debt and yield
The elementary principle of economics is that the price of anything is a function of demand and supply equilibrium. Higher demand pushes the equilibrium to a higher price point and vice versa. However, the bond markets in developed economies have been defying this principle for the past 25yrs. The debt of OECD countries rose sharply post the global financial crisis (GFC) in 2008-09; but the yield on government bonds fell till 2022, creating a negative divergence in bond supply and bond prices.
The situation has shown some signs of reversal in the past one year, but this may not last if the US Federal Reserve decides to begin easing rates sometime in the next 12months, while the latest debt ceiling deal results in a massive rise in bond supplies.
This trend is relevant for equity investors, since this could keep the cost of capital lower, affording much higher price earnings multiples to various businesses.
Deflationary pressures to persist
Post the GFC, the developed economies in particular have
struggled with persistent deflationary pressures. Despite unprecedented new
money printing and near zero (and negative) rates, major economies faced strong
deflationary forces. Consequently, the prices of financial assets and real
estate witnessed strong bull markets. The reported debt deal would result in
further strengthening of deflationary forces which are structurally aided by the
adverse demographic changes and changing consumption patterns.
Indian debt no longer lucrative to USD investors
The spread between US and India benchmark 10yr G-Sec yields (318bps) is presently at its lowest level, at least since the GFC. Given the hedging cost and just 2 notch above junk rating for India G-Sec, presently the Indian bonds may not be very attractive for the USD investors. Though there is not much empirical evidence available to substantiate this, there is a probability of rise in flows to Indian equity, which has been witnessing strong FPI selling for the past couple of years.
