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Date: August 28, 2018

How Today’s Debt Crisis May Impact Fixed-income Strategies [Video]

Created with Sketch. Run Time: 2:20
Michael Terwilliger Portfolio Manager Resource Credit Income Fund
In the current backdrop, investors should expect higher interest rates, higher borrowing costs, and slower growth. That's bad news for traditional fixed income.

Recent congressional budget analysis highlights a fact that many Americans already know: the U.S. has a major debt problem.

The U.S. budget deficit has ballooned by over $1 trillion in the last year. And as we move into the late stages of recovery, recent tax cuts may add some $1.5 trillion to the federal deficit over the next 10 years.

The Congressional Budget Office projects a fiscal deficit of 4.6 percent of gross domestic product in 2019, nearly unprecedented in a time of low unemployment. And by 2028, accumulated public debt may match the size of the economy: almost 100 percent of GDP—levels not seen since World War II.

What makes these numbers so unusual is their timing. The government usually spends itself out of recession, and pulls back when unemployment is low. That’s not the case in the current cycle.

Over the long term, solutions to our country’s debt situation appear elusive. Outside of extraordinary, and unlikely, economic expansion, the U.S. government would need to engage in painful spending cuts to tame the crisis—a politically unpleasant course.

The U.S. does have one unique advantage that will prevent the country’s balance sheet from dragging it off a cliff. The U.S. remains the global reserve currency. This dynamic will allow the country’s proverbial printing press to fund our debt obligations.

Regardless, in the near-term, investors need to consider how this situation will impact their portfolios. In the current backdrop, investors should expect higher interest rates, higher borrowing costs, and slower growth. Core inflation is on the rise, and the Federal Reserve has responded by indicating two more rate hikes this year.

That’s bad news for traditional fixed income. This will force investors to think differently about their investments.

They should instead look to shorten the duration of their fixed-income portfolios. Consider that senior secured loans have a duration of effectively zero, as the interest they pay may rise as rates do. This dynamic may help investors increase income and lower interest rate risk in today’s rising rate environment.

Resource Securities LLC, Member FINRA/SIPC.

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