Like most of us, I have been watching the endless debate about what to do about the United States’ federal government debt, and the debt ceiling. The most visible pundits have constantly warned about a financial Armageddon if the debt ceiling isn’t raised by next week — that the U.S. will find it’s debt instruments downgraded and will be forced to pay higher interest rates to continue to attract investors to buy U.S. Treasury bonds. Some others that haven’t been taken as seriously by the popular press don’t seem so concerned.
The truth, I believe, is that nobody knows so everybody is left to grind whatever political axe appeals to them. Leaving that aside, it seems to me that all investment decisions are a function of four factors: supply of the “thing” being considered, demand for it, the risk (i.e., uncertainty) related to the return on that possible investment, and alternative investments available. Given our government’s continuing appetite for borrowing there is no reason to expect the supply of Treasury instruments for sale to decline. In addition, although all of the current political panic hides this fact, the risk that bondholders that are due payment 6 months or more in the future won’t get paid really doesn’t change next Tuesday night, so this uncertainty shouldn’t drive investors away or cause them — by itself — to demand a higher return. That means that potential investors are left to consider their alternatives, and that will determine the ultimate remaining demand for U.S. bonds.
On that basis, my question is: If you have money to invest, where else are you going to put it? (Sure, real estate remains a great store of value and offers higher potential returns than most “hard” assets, but let’s stay focused on financial instruments here.) Based on financial news, Italy and Greece don’t look attractive, and they are potentially a huge drag on the entire Euro zone. China? Maybe, but how well protected is the average investor’s money there? Japan? Russia? South America? I don’t hear a rush to any of those investment markets. How about the U.S. stock markets? Certainly an alternative, and equities have seen a huge run-up over the past couple of years. Is that near the top? Isn’t the outlook for corporate growth and profitability dependent on the larger economic picture? Does that mean that the risk associated with investing in stocks is at least as high as the risk of investing in U.S. bonds? Maybe even higher?
I am not a professional investor or an investment advisor, but as I work through that line of thought, I don’t see anything that should drive demand for Treasuries down dramatically next week. If that’s true, then there is no reason for interest rates to spike unnaturally except maybe for short-term bonds. It increasingly looks like we may all get a chance to find out who’s right and who’s wrong, but my prediction is that the sun will still come up next Wednesday.
As for interest rates, they will inevitably go up, with or without the influence of this debate in Washington. In a separate post, I’ll comment on what they might mean for homebuyers.