Investors should pay attention to Treasury auctions
Last week we discussed the noise in the financial ether about the fiscal challenges of the U.S. Federal government. High profile CEOs are expressing concern, high profile investors are expressing concern, the financial press is fueling the fire and it's all over the internet.
By any reasonable standard, the United States national debt has reached levels which for many other nations would lead to a potential negative debt or even currency predicament. When investors evaluate government debt levels the line in the sand is a national debt not exceeding 100% of a nation's total economic output, or GDP. The U.S. debt now stands at roughly 125% debt to GDP.
When investors evaluate a nation's fiscal deficit -- meaning the amount of money it borrows to fund the government over and above what the government collects in taxes -- the line in the sand is 3% of GDP. The U.S. is now borrowing 6% of GDP. And when total interest costs are considered, the interest costs on the national debt now exceed the money spent on the U.S. military, as well as social programs like Medicare and Medicaid. The numbers at this point appear unsustainable.
In order to right this runaway debt ship, the government has four primary options. The first is austerity, or simply spending less and becoming more efficient to reduce deficits and ultimately debt. Like 'em or hate 'em, DOGE was the American version of this attempted austerity. It is clear from the smugness of those who opposed this austerity process, DOGE is losing momentum, and six months into the Trump administration I do not believe there will be any meaningful austerity -- the problem is just too large.
The second option is default. Default occurs when a government effects policies resulting in a failure to pay interest or principal on its debt. A default from the U.S. Federal government would be an earth-shattering disaster and remains an extremely unlikely outcome and small risk.
Thirdly, a government borrowing in its own currency (like the U.S.) can inflate its currency to reduce the burden of the debt. This is accomplished by the creation of new money supply to pay its debts, or printing money, thereby reducing the value of the dollars it owes and the burden of paying interest and principal back to creditors. With the United States emerging from the very inflationary COVID period, this option is less practical right now as continued high inflation could have serious political, financial and even social consequences.
And fourth, the government can attempt to grow its way out of the debt challenge, by increasing the size of its economy and by osmosis its tax base in order to make the debt ratios discussed above more palatable. Listening to Trump administration rhetoric, this appears to be the preferred policy response, but it is also the most uncertain and difficult to engineer. Donald Trump seems to love big risk, big return stakes and this unique financial culture appears to be driving fiscal policy in the administration. We would all be smart to be skeptical as to whether the U.S. can grow itself out of its debt problems this time, but there is still hope.
So, if the national debt moves from the festering but theoretical problem level to the acute and urgent crisis stage, what would the sequence of events look like? Well, as discussed last week I think the first warning sign would come in the form of a failed Treasury auction. The government is selling new bonds in Treasury auctions all the time, and most of the time these auctions attract about as much attention from individual investors as power lines and water pipes.
A failed auction would occur when there are not enough buyers (bids) to purchase all the bonds being sold at the interest rate offered by the government. This could occur in a couple different ways, all of which would rattle markets if they occurred. The technical aspect behind these potential failures is beyond the scope of this column, and the government has a number of tools it can use to prevent this from happening.
Which leads me to believe at this stage in the debt cycle investors may perceive the utilization of some of these failure prevention tools as an auction failure, making it difficult for individual investors to understand why a Treasury auction that didn't actually fail is driving interest rates higher and likely stock prices lower.
Over the next few quarters, I expect Treasury auctions to be observed very closely by investors, attempting to gauge demand from foreign investors and non-primary bank investors in the U.S. I really don't like putting Treasury auctions on the list of financial news investors need to be cognizant of, but until the government's fiscal house is improved and some of the high-profile angst comes out of the financial ether, I'm afraid this "tail risk" topic must be added to the list of investor stress.
The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for any individual. Stock investing includes risks, including fluctuating prices and loss of principal. No investment strategy can guarantee a profit or preserve against loss. Past performance is not a guarantee of future results. Marc Ruiz is a wealth advisor and partner with Oak Partners and registered representative of LPL Financial. Contact Marc at marc.ruiz@oakpartners.com. Securities offered through LPL Financial, member FINRA/SIPC.
