Weekly Access

Politicians Changing Attitude toward Debt


By Michael McKeown, CFA, CPA - Chief Investment Officer

It was only a few years ago that people from both sides of the aisle in Congress were calling for austerity.  The same went for members of the ECB and politicians in Germany and the UK.  All across the globe cutting debt was the way to prosperity.

It turns out those policies were wrong.

Perhaps ‘wrong’ is too harsh a term.  'Poorly timed' given the economic situation, may be more descriptive.

Countries are changing their approach when it comes to debt.  This may be due to the rise of populist political movements or growth that is not what it used to be.  In July, several countries announced plans to expand spending.

  • A 60 billion Canadian dollar fiscal stimulus plan was unveiled by Justin Trudeau, including infrastructure spending.  This equates to 3% of GDP.
  • 20 trillion yen stimulus package including projects for high speed rail and infrastructure (including loan and guarantees) was introduced.  This equates to 4% of GDP.
  • UK’s Philip Hammond, Chancellor of the Exchequer, indicated a possible stimulus package this autumn to counter the negative effects of the vote to leave the European Union.

"The US is doing better than the rest not because its quantitative easing worked better, but because it is the only country with a central bank that openly argued against fiscal austerity."  This quote is from Richard Koo, Chief Economist from the Nomura Research Institute. He is one of the few economists to witness and live through Japan’s 20 years of quantitative easing.  In addition, he correctly diagnosed the balance sheet problems for the nation.

The U.S. indeed turned out to be the least austere, despite some people actively campaigning for it.  This turned out to be the correct policy.  Why? Households were deleveraging and corporations not investing.  A government deficit was necessary to fill the gap left by households and corporations.  It is a big reason why the U.S. is the only country out of the 4 major economic blocs to not battle deflation over the last year.

The chart above shows the inflation rates across the developed world.  The U.S. topped Europe, Japan, and the UK at 1% over the last year.

Both of the major parties' Presidential candidates this fall both support greater spending.  The fiscal spending impulse could result in higher inflation.  In turn, this could cause bond investors to want more compensation for inflation risks.  This would cause yields to rise and bond prices to fall.

Just like greater fiscal spending, rising bond yields go against the trend of the last several years.  A rise in U.S. bond yields over the next year or two, does not mean a secular change is ahead.  Other factors, such as the yields offered by global bond markets and growth trends, will determine the path of interest rates.

Adding to the short-term risk of a rising bond yields is the positioning of real money traders.  Commercial traders have the largest bet against bonds since early 2013 (just before the Taper Tantrum when yields spiked).  In contrast, small traders have the largest bet on bonds in four years, which is usually a contrarian indicator.

The chart above shows that the U.S. 2-year Treasury note yields far above Japan and Europe.  Thankfully, it is in positive territory.

Based on the data presented, and compared to the rest of the world, America is not doing that bad.


This material is based on public information as of the specified date, and may be stale thereafter. Aurum Wealth Management Group and/or Aurum Advisory Services has no obligation to provide updated information on the securities or information mentioned herein. Actual events may differ from those assumed and changes to any assumptions may have a material impact on any projections or estimates.

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