Research

Unsustainable debt: Strategic asset allocation for a new era

With no simple solutions to stabilizing debt and policymakers facing complex financial-market challenges, investors may need to reconsider their approach to diversification across asset classes, geographies, and strategies.

Key Takeaways
  • The rise in interest rates, coupled with persistently high fiscal deficits, is creating further upward pressure on U.S. government debt levels that are already at record peacetime highs.
  • The upward adjustment in long-term Treasury bond yields puts them closer to what we would consider fair value, but if debt keeps rising over the medium term, yields may need to go higher to attract the more price-sensitive investors that now make up the vast majority of Treasury ownership.
  • It’s unlikely that high enough real economic growth can be achieved to single-handedly level out the debt trajectory, implying policymakers may be increasingly motivated to attempt financial repression to hold interest rates at artificially low levels (even in an environment of persistent supply-side inflation pressures).
  • These dynamics imply monetary and fiscal policies may be more challenged to respond to economic or financial shocks, and potential policy swings may generate bouts of financial-market volatility; but we don’t believe a catastrophic loss of confidence in the U.S. is the most likely scenario.
  • Given the unprecedented backdrop, we believe prudent strategic asset allocation warrants maximum diversification: global assets denominated in non-U.S. currencies; hedges (commodities, real assets, TIPS, gold or bitcoin), and alternatives, including liquid alternatives.
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Unsustainable debt: Strategic asset allocation for a new era