Morgan Stanley warns on US debt: The real risk is investors shifting to bonds
As the US federal debt exceeds 40 trillion dollars, Morgan Stanley has pointed out that the real breaking point for markets could occur with a shift toward bonds.
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The fact that the US federal debt has exceeded 40 trillion dollars has reignited debates regarding the country's fiscal outlook. However, according to Morgan Stanley's assessment, there are no widespread signs of stress in the markets for now. The institution points out that the main issue to watch is not the nominal size of the debt, but rather a potential change in investor behavior.
Andrew Sheets, Morgan Stanley's Head of Global Fixed Income Research, stated that the federal debt the US accumulated over its approximately 240-year history was around 20 trillion dollars, whereas another 20 trillion dollars has been added to the debt stock in the last 10 years.
Despite this, it is emphasized that private sector balance sheets are more resilient compared to past crisis periods. The fact that the rapid increase in public debt is not accompanied by a similar wave of borrowing on the corporate and household side is cited as one of the factors increasing the economy's resilience against the high-interest-rate environment.
In the US, the ratio of household debt to gross domestic product, which was approximately 70 percent in 2000 and 74 percent in 2019, has fallen to about 67 percent today. Furthermore, the fact that a significant portion of consumers turned to long-term, fixed-rate mortgage loans during the low-interest period limits the impact of current high interest rates on household budgets.
THE CRITICAL THRESHOLD WATCHED BY MARKETS
In the Morgan Stanley analysis, it is stated that the risk to the markets is not limited only to high interest rates. According to the institution, a critical scenario could emerge if investors begin to find bonds more attractive than stocks.
US 30-year bonds offer a real return of approximately 300 basis points above expected inflation. The yield on long-term, investment-grade corporate bonds is around 6.2 percent. However, high bond yields have not yet triggered a widespread shift from stocks to fixed-income assets.
It is stated that the growth in corporate profits is the decisive factor in the S&P 500 maintaining its strong appearance despite the rising interest rate environment. Strong profitability partially balances the pressure of interest rates on stock valuations and helps stocks maintain their appeal for investors.
However, it is assessed that the balance could shift if there is a significant slowdown in the growth rate of corporate profits. In such a case, the appeal of bond yields could become more prominent, and the shift of investors from risky assets to fixed-income securities could accelerate.
Therefore, according to Morgan Stanley, the main topic to watch for the markets is not just the growing US debt stock; it will be the conditions under which this debt is financed, the course of bond yields, and potential changes in investor risk appetite.