The unsustainable state of the U.S. fiscal budget is leading to a significant increase in the issuance of Treasury bonds—and when combined with demand challenges, a higher-for-longer rate environment appears justified. Although an impending economic slowdown might limit the potential for capital appreciation, the assurance of a steady income from Treasurys makes them attractive amid an uncertain outlook.

U.S. federal net interest expenditures
Percent of revenues, 1985–present, forecasted through 2033

Line graph

Source: U.S. Treasury Department, Congressional Budget Office, Bloomberg, Principal Asset Management. Data as of October 31, 2023.

With U.S. Federal budget deficits averaging over $400 billion each quarter, the sustainability of U.S. fiscal policy is increasingly questionable. Currently, the government is spending nearly as much on interest payments (over 16% of revenues) as on major programs like Medicare and defense due to interest rates being notably higher than in the past 15 years. Forecasts project this rising to 20% by 2033.

The government has been issuing a substantial amount of Treasurys to manage these large deficits, offering higher yields to make them more attractive to investors. This need for higher yields, combined with a restrictive monetary policy, reductions in central bank balance sheets, and decreasing foreign demand, warrant a higher-for-longer rate environment. All told, higher yields and supply-demand dynamics leave Treasurys near fair value.

While decelerating cyclical forces typically warrant raising bond allocations in portfolios, an abbreviated economic slowdown may be insufficient to reward investors with abundant Treasury gains – a deep recession would likely be needed for a sustained and substantial rally.

Without needing to take added duration risk, today’s Treasurys offer extremely attractive yields. And while the potential for capital appreciation might be limited in the face of an impending economic slowdown, the assurance of a steady income from Treasurys makes them a solid option for investors prioritizing stability heading into an uncertain 2024.


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