According to Ashish Shah, a strategist at Goldman Sachs Asset Management, 2024 has the potential to be a stellar year for bonds. He made this bold prediction on December 8th, 2023, citing several factors that contribute to his optimistic outlook. Why is Goldman Sachs' Chief Investment Officer so optimistic about the bond market?
The recent rebound is the first reason. The bond market has already begun to stage a comeback after experiencing a historic rout earlier in 2023. This indicates that investors are regaining confidence in the asset class. The second reason is inflation’s continued decline. Shah believes that inflation is likely to keep declining in 2024. This would lead to a more favorable environment for bonds, as interest rates are expected to stabilize or even decline. The third reason is the potential recession. A mild recession in 2024 could further boost demand for bonds, as investors seek safe havens for their capital. And the fourth reason is the attractive yields. With yields currently above 4% for both 5-year and 10-year Treasuries, bonds are offering investors a relatively attractive return compared to other asset classes.
If inflation continues to decline in 2024 but interest rates remain unchanged, i.e., they stay high; then the price of existing bonds will continue to fall as the yield continues to increase. In that case, new bonds will be more attractive than existing bonds. On the other hand, if interest rates are expected to be cut based on the assumption that inflation reached its target rate of 2%, as most people predict it would be the case in 2024, then the price of existing bonds will increase as their yield will decrease, which will make demand for existing bonds more attractive to investors.
The major question to ask ourselves is, how will the bond market affect the national debt? If we rely on Shah’s predictions, then we can expect the national debt to rise significantly next year. The primary way the bond market affects the national debt is by providing the government with the funds to finance its spending.
When the government spends more than it collects in taxes, it creates a budget deficit. To cover this deficit, the government issues bonds. That means, as interest rates tend to be lower, it makes it cheaper for the government to borrow money to finance its budget deficit and service its existing debt. This, on the other hand, increases the national debt.
The national debt has reached an unsustainable level. Today, the U.S. economy has incurred nearly $34 trillion in debt. While a bullish bond market reflects that investors are generally optimistic about the economy and have confidence in the government's ability to manage its finances, which would lead to an increased demand for government bonds, a bullish bond market would continue to make the U.S. economy overleveraged because the more bonds the government would sell to investors, the larger its spending would be, ergo its deficit, and the larger its deficit will continue to be, the larger would be the national debt. And lastly, if the bull market is fueled by excessive monetary stimulus, it can lead to inflationary pressures. This could erode the purchasing power of the national debt and make it more challenging to manage in the future. The reality is that an eocnomy with a very large and unsustaible national debt is not a healthy economy.