Good Morning Ladies and Gentlemen
”The magnitude and speed at which these prices are coming to us are somewhat unprecedented in history.”
John David Rainey, Walmart’s CFO
In the realm of financial investments, it is essential to recognise that fear can be an inadequate guide for decision-making. Historically, evidence suggests that a long-term investment strategy, particularly one that includes allocations in robust dividend-paying equities coupled with a measured approach to market volatility, has yielded favourable outcomes.
Debt Delinquencies
According to recent data from the Federal Reserve Bank of New York, an increasing number of Americans are struggling to keep up with their debt payments. The percentage of credit card balances at least three months overdue has risen to its highest level in 14 years. While overall credit card balances have decreased, the share of individuals unable to meet their payment obligations has risen. In other words, US households collectively borrow less on their credit cards, yet the proportion of borrowers experiencing difficulty repaying their debts is increasing.
Interest Rates Must Go Down
Lower interest rates are crucial for governments of heavily indebted countries. Lower interest rates are also vital for consumers in countries that heavily rely on domestic consumption, as well as for homeowners relying on mortgages. As we have learned above, the proportion of U.S. borrowers experiencing difficulty repaying their debts is rising. This is particularly important because the United States benefits from robust domestic demand, with consumption accounting for approximately 70% of its GDP. If consumption increases steadily at a rate of 2%, it can contribute approximately 1.4 percentage points to GDP growth. Conversely, sluggish consumption could significantly impact the country’s overall economic performance. At the same time, the U.S. government is spending roughly 20% of its entire income on interest payments on its debt. What exacerbates the situation is that Japan, the largest creditor of the United States, and the Japanese government, which is even more indebted than the U.S. government, are currently facing significant upward pressure on long-term JPY-debt interest rates. As Albert Edwards, strategist at Société Générale, points out, “if sharply higher JGB yields entice Japanese investors to return home, the unwinding of the carry trade could cause a loud sucking sound in US financial assets.”
Carry Trade
What is the carry trade, some readers might wonder. The carry trade can be illustrated through the example of Japan and the U.S. In this scenario, investors borrow funds in a low-interest currency from a highly indebted country like Japan and then invest that money in high-interest, fixed-income products in a country with lower government debt, such as the U.S. (lower government debt is a very relative term in this example, as the effective government debt is still very high). Why is the debt situation significant? Generally, over time, the currency of a country with higher debt, such as Japan, tends to depreciate relative to the currency of a country with lower debt, like the U.S. This creates a dual benefit for investors. They not only capitalise on the interest rate differential between Japan’s low rates and the U.S.’s higher rates, but they also stand to gain from the favourable currency exchange as the USD appreciates against the JPY due to Japan’s higher government debt.
The Reverse Of The Carry Trade
What Albert Edwards, strategist at Société Générale, has attempted to explain in his FT interview is that rising yields in Japan may lead to a lower interest differential between the USD and JPY and, at the same time, may lead to a strengthening of the JPY, consequently and also driven by an unwinding of the carry trade. This makes the carry trade less profitable, if not risky.
Consequences of a Reverse of the Carry Trade
The repercussions of the unwinding of the carry trade between the Japanese Yen (JPY) and the U.S. Dollar (USD) may manifest as significant challenges in refinancing U.S. government debt. This situation could subsequently lead to elevated interest rates on U.S. government bonds, contributing to an increase in inflation and potentially precipitating an economic recession in the United States.
Expectations
What can we, therefore, expect on the interest front in the upcoming months?
European Central Bank
The ECB key interest rate (deposit rate) has been 2.25% since the meeting on 17 April. At the meeting on 5 June, it looks as though interest rates will be cut again by 25 basis points. The ECB’s target range for the deposit rate (key interest rate) is 1.54% in March 2026, meaning that the 1-month euro futures give the ECB three interest rate cuts of 25 basis points each until spring 2026.
Federal Reserve System
As of the present date, the United States’ key interest rate is positioned within a range of 4.25% to 4.5%. The Federal Reserve refrained from altering this rate during its most recent policy meeting. As indicated by futures traders, market expectations suggest the anticipation of four potential interest rate reductions over the forthcoming twelve months. Specifically, these reductions are projected to occur in September and December 2025, as well as in January and June 2026, with each cut of 25 basis points.
Additionally, analysis of Fed funds futures reveals that market participants assign a very low likelihood of any change in interest rates at the upcoming meeting scheduled for June 18.
Conclusion
It is essential to acknowledge the significance of President Trump’s actions. While he has been vocal in his appeals for Federal Reserve Chair Jerome Powell to reduce interest rates, his emphasis on tariff policies and recent tax cuts may have undermined the justification for future rate reductions. The Fed, concerned about the potential for another inflationary shock, has indicated its intention to maintain restrictive rates as a safeguard against allowing inflation to spiral out of control once again. After all, maybe “TACO” is not that bad, or at least better than unintended far-reaching economic consequences.
Ladies and Gentlemen
Feel free to send your messages to smk@incrementum.li.
Many thanks, indeed!
I wish you an excellent start to the day and weekend!
Yours truly,
Stefan M. Kremeth
CEO & Head of Wealth Management
Incrementum AG – we love managing assets
Tel.: +423 237 26 60
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9494 Schaan/Liechtenstein
Mail: smk@incrementum.li