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.

Fixed income
Macro views
Disclosure

Investing involves risk, including possible loss of principal. Past performance is no guarantee of future results and should not be relied upon to make an investment decision. Fixed‐income investment options are subject to interest rate risk, and their value will decline as interest rates rise.

The information presented has been derived from sources believed to be accurate; however, we do not independently verify or guarantee its accuracy or validity. Any reference to a specific investment or security does not constitute a recommendation to buy, sell, or hold such investment or security, and does not take account of any investor’s investment objectives or financial situation and should not be construed as specific investment advice, a recommendation, or be relied on in any way as a guarantee, promise, forecast or prediction of future events regarding an investment or the markets in general. The opinions and predictions expressed are subject to change without prior notice.

Principal Funds, Inc. is distributed by Principal Funds Distributor, Inc.

Securities are offered through Principal Securities, Inc., 800-547-7754, Member SIPC and/or independent broker/dealers.

Principal Asset Management leads global asset management at Principal.®

For Public Distribution in the U.S. For Institutional, Professional, Qualified and/or Wholesale Investor Use only in other permitted jurisdictions as defined by local laws and regulations.

© 2023, Principal Financial Services, Inc. Principal Asset ManagementSM is a trade name of Principal Global Investors, LLC. Principal®, Principal Financial Group®, Principal Asset Management, and Principal and the logomark design are registered trademarks and service marks of Principal Financial Services, Inc., a Principal Financial Group company, in various countries around the world and may be used only with the permission of Principal Financial Services, Inc.

3239647