US Treasury Bonds – the trend is your friend

September 25, 2018


The US Treasury Bond bull market has persisted for more than three decades since Paul Volcker crushed inflation by hiking the Fed Funds Rate to over 15% in the 1980s, and this longstanding trend looks set to continue.

As the Fed tightens monetary policy, credit becomes inaccessible to some businesses and consumers, which results in a countervailing income effect, lower inflation and lower interest rates. The velocity of money remains persistently weak and gross fixed capital formation has been falling for decades.

Both developed and emerging market economies continue to take on excessive debt burdens, and over time this debt build up leads to weaker economic growth, which is explained best by the law of diminishing returns. According to the IMF global debt to GDP reached 225% this year, further constraining future growth potential as the transitory effect of debt financed stimulus spending diminishes.

The diminishing returns from an increase in debt can be illustrated by looking at GDP growth generated per dollar of debt incurred. On a global basis, one dollar of debt generated 36 cents of GDP growth in 2007, today one dollar of debt only generates 31 cents of GDP growth. Comparatively the US debt profile is better than the global average, however it has also deteriorated since 2007, and today the US generates 40 cents of GDP growth for each dollar of additional debt.

A large part of the appeal for US Treasury Bonds stems from the USDs reserve currency position, as well as its dominance in global trade and finance. 85% of FX transactions involve the dollar, almost 100% of oil transactions are done in dollars, and central bank reserves held in dollars make up over 60% of total global currency reserves. The Euro is the second most held reserve currency, and it makes up 20% of global currency reserves.

Global investors have, and will continue to protect capital with fixed income, particularly US Treasury Bonds. Foreign purchases of US government debt remains robust, and increasingly so, as US Treasury data shows a solid increase in foreign holders of US government debt in July.

Additionally, the bid-to-cover ratio shows strong demand when looking at auctions of US 10-year notes.

Ultimately, there is not yet a viable alternative to the dollar system, and prudent investors will continue to seek safe haven in US Treasury Bonds during the months and years ahead.

 

 

 

Disclaimer: Please note that while Valbury Capital has made every attempt to ensure the accuracy and reliability of the information provided in this document it can give no warranty of any kind. The information provided is intended to be of a factual nature only and is not intended to amount to investment advice or to contain any form of investment recommendation. No person should rely on or use the information provided to form any investment decision