Arun Singhal, founder and chief investment officer (CIO) at Indicus Capital, discusses the growing accumulation of US and global debt on sovereign balance sheets, the recent Moody’s US credit downgrade, and what it means for markets.
The CIO unpacks whether there are questions over the US exceptionalism narrative and investing in dollar-denominated assets long term.
Looking elsewhere, he discusses the worrying signs in the Japanese government bond markets; how it’s impacting the pricing of risk, and the potential wider implications on global bond markets.
Interview
Jo Gallagher Over the past two weeks we’ve had Moody’s downgrade US credit and the Trump administration is in the middle of trying to pass a major tax bill. What does this mean for markets?
Arun Singhal We need to look at the underlying factors, even before the Moody’s downgrade, the market was beginning to get nervous about the fiscal situation of the US. In our view, Moody downgrade is just a symptom where the underlying problem is the deteriorating balance sheet of the public sector after the 2008 financial crisis. Since then, we have had multiple rounds of quantitative easing, and zero negative interest rates in most of the developed world which has led to an accumulation of huge debt on sovereign balance sheets. These debts were serviceable when interest rates were very, very low, but post-COVID, interest rates have gone up and we are now reaching a point where the US interest rate burden alone will be about 1.2 trillion dollars next year. And I think these are some of the things which markets have become concerned about. You can see that in the CDS spread of the US sovereign, which is trading very close to where Greece is trading. I think in the U.S. There is additional element of political dysfunction. We have kind of a new tariff policy and you’re right to point out the new tax bill which is potentially going to add several trillion dollars of deficit to the balance sheet. So I think these are some of the concerns which the market has.
Jo Gallagher So are there questions long term over the US exceptionalism narrative and investing in dollar denominated assets?
Arun Singhal Exceptionalism is something which is earned and it’s not an entitlement. When we came to the beginning of this year, the US assets were trading at a wide premium over where the rest of the world assets were. Also, the dollar was very expensive compared to the other currencies. Since then, we have seen a little bit of valuation adjustment. The US equity market is kind of flatish this year while some of the other major equity markets have outperformed. There are at least double digits or even more. So if you look at the markets like China, Europe, these markets have outperformed the US market by a very heavy margin. The Polish equity market is one of the best performing markets in the world, which is up more than 40%. You’ve had a lot of adjustment in currencies as well. Dollar is weaker across the board, across various currencies. We have seen the dollar especially against the Asian currencies, some very very large moves a couple of weeks ago where it moved like seven to eight percent in just two trading days which is something which is completely unheard of. So you’re beginning to see some diversification away from the US. The question now is this just a little bit of a diversification and valuation story or is it something where the market is losing confidence in US assets? And my answer to that question is that right now it’s the former. I think the U.S. still has a lot of strengths. It’s the depth and liquidity of its capital market, its economy which has been growing pretty rapidly, faster than most of the other developed market economies and there is a lot of innovation. So I think some of those trends are still persisting, but yeah, I think there is a diversification which is happening.
Jo Gallagher Looking elsewhere there are also some worrying signs out of the Japanese bond markets with yields rising to record highs recently. What’s important to be paying attention to here?
Arun Singhal I think Japan is an interesting case. I call it the exhibit A in my macro reckless framework, because it’s been kind of a pioneer in some of the policies which other central banks have followed, whether it’s zero and negative interest rates, whether its quantitative easing or yield curve control. Japan was a very peculiar situation where the debt to GDP kept going up because of the amount of stimulus which the Japanese government was injecting in the economy. But at the same time, their interest rates are very, very low because Bank of Japan was buying more than 40% of the government debt which was being issued. And if you look at Japan, it has a debt to GDP of 250%. Because of inflation, Bank of Japan has had to change their monetary policy. They cannot do the same degree of yield curve control which they did earlier. They have had to raise interest rates, even though by a very small amount and I think this is kind of bringing to the fore that when you control the price of a certain asset and not let the market forces determine its price, then you don’t know what the actual price of the asset is. Last week, we had a situation where the 20-year option had a massive tail. It was one of the weakest options since 1987, and there was complete panic in the Japanese government bond market. And I think this is something which is celebrating across all the sovereign markets where people are looking at what’s happening in JGB market to see how they price risk in their own market. Also, there are concerns about whether this leads to some sort of unwind of carry trade. It almost feels like a financial crisis which is emanating from something which was supposed to be risk-free and I think that’s what makes it so fascinating.
Jo Gallagher I’d like to thank Arun for his insight and, of course, you for watching, this has been Trader TV This Week.
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