The markets are anything but predictable. The good news is there are funds which can do well both in good and bad markets. A fund report grabbed my attention today. The long-short fund performed well within my expectation last month. The fund lost 1% in its long book but made 2.6% in its short book. Since our share class returns are forex hedged, the fund’s long US stock positions did not benefit from the dollar strength.
Here is a section:
The current “disinversion” of the US Treasury yield curve whereby lower longer-term rates of interest rise toward those on shorter-term maturities has perplexed many market participants given ongoing moderation of headline inflation measures. Our view is that we are witnessing the early stages of a bond market revolt against unfettered government spending at a time of full employment.
The Congressional Budget Office has recently estimated that the underlying fiscal year Federal deficit is on track to double from USD1 trillion in 2022 to USD2 trillion in 2023 (8% of GDP). Only politicians still believe in magic money trees.
This time last year, President Biden, apparently without a hint of irony, was warning the UK Truss government about the “mistake” of fiscal stimulus at a time when central bankers were tightening monetary policy to combat inflation. When asked about US dollar strength in an ice cream parlour in Portland, Oregon, Biden explained: “The problem is the lack of economic growth and sound policy in other countries”. In fact, the current strength of the greenback reflects speculative capital flows based on loose fiscal policy which requires ever tighter monetary policy.
The current USD2 trillion primary deficit compares with the total amount of Treasury bills, notes, and bonds of USD25.5 trillion on which the current interest charge is an annual USD800 billion (which will rise from a weighted average of 3% toward 5% as it is refinanced). The Fed which owns USD5 trillion of US government debt is currently reducing its holdings by USD95 billion per month (USD1.14 trillion annualized).
Foreigners who own USD7.7 trillion (notably Japan with USD1.1 trillion of Treasury assets and China with USD835 billion) can no longer be relied upon to recycle their capital into Treasuries. Around USD5 trillion (20%) of US government debt is currently in bills, maturing over the next 12 months. This means that there is at least a USD9 trillion gross, or USD4 trillion annual net supply imbalance in the US Treasury market which speculative inflows (or overseas repatriation) of private capital must now fill.
This USD4 trillion funding gap compares to current Institutional Investor ownership (pension funds, banks, mutual funds, insurance companies) of US government debt of just USD8.8 trillion! In other words, the need to fund the US Treasury deficit can be consistent with greenback strength but must also crowd out investment in all other asset classes: investors must continue to feed the Treasury deficit beast.