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Market Commentary for the 3rd Quarter, 2023

The Problem with Treasury Bonds is the Issuer, not the Economy

The robustness of this economic cycle continues to be stronger than most anticipated. GDP came in at 4.9% for Q3. If you look at headlines across the board, from inflation to wage growth to GDP, it may appear as if the economy is booming. Anticipating the turn in an economic cycle is just like watching paint dry. This market has been the story of the Super 7 stocks in the US (Apple, Microsoft, Alphabet, Meta, Tesla, Nvidia), coupled with the Semiconductors and GLP-1 companies.

Bonds Continue Their Decline

Bonds continued their decline, falling at a near record pace and extending their 3+ year drawdown, starting during Covid (the 30-year treasury bond peaked April 2020, while the 10-year peaked July 2020). The 30-year treasury bonds have lost 60% of their value since Covid, a drawdown that is even greater than the US stock market drawdown in 2008-2009. Higher for longer has finally hit the long end of the yield curve. The US Treasury Federal Deficit is currently at -6.26% of record level GDP numbers. To put the debt burden into perspective, the Government Interest Expense is expected to surpass Defense spending next year. That approximately 3.2% of annual GDP spending on interest expense is basically the equivalent of only paying your credit card minimums each month.

Credit spreads and defaults have picked up as of late. The numbers are still within the range of historical averages, but that could change soon. Some have questioned why duration is getting hit and corporate spreads have not widened. It is a difference of balance sheets and debt issuance maturity. The US government has a balance sheet problem. Eventually, this will also lead to much wider spreads across the risk spectrum, but it is hard to say when. Credit spreads have been suppressed as corporations were able to minimize overall issuance, which ultimately builds up a wall of issuance coming due in the next few years. Over the last few years of these commentaries, a theme of ours has been that sometimes the duration of economic stagnation, rather than the magnitude of a recession, is more telling of the longer lasting economic impacts it has. Eventually we will hit that maturity wall. Q4 of 2023 and all of 2024 will face the massive maturity wall of the government, while corporates are a little better spread out between 2024-2027.

Read the full commentary here.


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