Head of Fixed Income Strategy
Summary: The US government is forced to increase fiscal spending exponentially amid the 2024 elections to keep the economy going and avoid social unrest. Due to lingering inflation pressures and foreign investors repatriating capital, demand for US Treasuries remains sluggish, provoking a spike in US Treasury yields. In a desperate attempt to normalise borrowing costs, the US government makes income from government bonds tax-free.
An increasingly uncertain geopolitical environment forces the US government to expand defence spending, while the Federal Reserve continues to tighten financial conditions amid a second wave of inflation. To avoid social unrest, Congress is forced to increase fiscal spending.
With the budget deficit quickly spiralling above 10% of the GDP, a level that over the last century was exceeded only during the Second World War and the coronavirus pandemic, the government needs to foster demand for US Treasuries urgently. The attention goes to the stock market, where the ‘Magnificent Seven’ have now become twelve, thanks to a missed downturn and government support programs directed to lenders and homeowners. To join the club are Eli Lilly, Novo Nordisk, Visa, JPMorgan Chase, LVMH, ASML and TSMC. As the ‘Twelve Titans’ multiplies their valuations within a few months, inequality increases between investors and non-investors.
The US government understands that political stability depends on its ability to continue financing a huge deficit through more US Treasury issuance, thus lower interest rates. Therefore, increasing the domestic attractiveness of US Treasuries versus stocks becomes critical. Under intense pressure from the White House, Congress makes capital gains and interest income on US Treasuries tax-free. With government debt in the hands of domestic investors, the cost of funding becomes less volatile.
This dramatic move marks the end of capitalism, as money rotates from private corporations to the public, and holding riskier assets becomes more expensive. Counterintuitively, the ‘Twelve Titans’ consolidate their market dominance, as they benefit from long-term lower cost of funding, while the rest of the stock market collapses. Despite the government's failure to resolve inequality, lower borrowing costs extinguish social unrest. What follows is a long period of nationalisation and government intervention in critical sectors that are struggling to attract capital.
Market impact: US Treasuries rally across all tenors, and the yield curve bull-flattens as investors can lock in the highest yields in decades without tax burdens. The stock market tumbles, but a selected group of cash-rich companies benefit from an inverted yield curve.
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