When Does Higher U.S. Debt Start to Matter?

**Andrew Sheets** (0:00)
Welcome to Thoughts on the Market. I'm Andrew Sheets, Global Head of Fixed Income Research at Morgan Stanley. Today, at what point do higher yields and higher debt actually matter? It's Wednesday, August 26th at 2 p.m. in London.
In its first 240 years, the United States of America accumulated roughly $20 trillion in federal debt. The country has borrowed another 20 trillion in just the last 10
The question for investors is when this debt load will act as a break on economic activity or worse, create stress that disrupts today's relative calm. So let's start with the first question. For economic activity, the bar seems pretty high. You see, even with all the activity around AI, US corporate debt as a share of the overall economy is broadly unchanged in the last decade and actually lower than where it was before the pandemic. The balance sheets of the household sector in the US are even stronger. Household debt to GDP is lower than where it was prior to COVID and lower than where it was in the year 2000 And this may even understate the strength, because much of this debt is locked in at historically low mortgage rates, while household assets, the other side of the balance sheet, have soared to record levels. That may help explain why both consumers and businesses have remained more resilient than expected this year, despite the higher interest rates and energy prices. This divergence of trend between public and private balance sheets is also global. Europe has also seen higher government debt offset by even more private sector deleveraging, while Japan has seen rising public borrowing and pretty stable private sector leverage. To some degree, this divergence between the public and private sides of the economy reflects a policy choice. Governments determine how to balance taxation and spending, and many countries, not just the US., have reduced taxes over the last decade, while allowing public borrowing to increase. A deterioration of public sector finances relative to private sector finances? It's not especially surprising, given that choice. If strong balance sheets are helping US households and companies be less sensitive to higher rates, where should we look for stress? Well, for all of this debt, the US bond market is actually still pretty well behaved. US inflation expectations are roughly unchanged year to date. Expected bond market volatility is historically low. Indeed, one reason that recent intervention by the US. Treasury into the bond market was such a surprise to investors was the lack of these usual stress markers.
Instead, the point at which these higher yields might have a larger market impact may be up to another factor, asset allocation. Today, 30-year Treasury bonds yield about 3% more than expected inflation over that period. Long dated US investment-grade corporate bonds once again yield more than 6%.
And so the question of when higher yields begin to matter may be less about when businesses stop borrowing or consumers stop spending and be more about when investors decide that bonds offer better value than stocks.
So far, Morgan Stanley Research is not seeing clear evidence of that shift. Fund flow data and market correlations do not suggest a significant reallocation away from equities and strong earnings growth is helping support the equity valuation case. But these are metrics that we'll be watching. In the meantime, we think that rising US debt and Treasury market intervention may weaken the US dollar, especially against a high-yielding currency with much, much lower debt levels, the Australian dollar.
Thank you, as always, for your time. If you find Thoughts on the Market useful, let us know by leaving a review wherever you listen. And also tell a friend or colleague about us today.

**SPEAKER_2** (4:03)
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