The chief investment officer of the world’s largest active bond manager says investors could be underestimating how much flexibility the US has to address its growing fiscal deficit.

As long duration US Treasury bonds continue to sell-off, investors are growing increasingly concerned over the impact this will have on the swelling US national debt, which surpassed the $40trn mark in August.

This has been made worse by the US Federal Reserve embarking on an interest rate hiking cycle, prompting markets to price in higher borrowing costs and inflation, pushing long-dated US 10-year yields to the 5.3% level.

Indeed, PIMCO chief investment officer Dan Ivascyn told a recent media briefing in Hong Kong that inquiries around the sustainability of the US fiscal deficit is one of the most common questions arising from the firm’s clients.

However, he argued that the strong US economy, combined with the US dollar enjoying a global reserve currency status will give it more time to get deficits back in order.  

“The US government will have to pay higher rates than they would otherwise because they are issuing a lot of debt, but we do think that the US has some time to get deficits back to a more sustainable trajectory.”

“In the next several years, there will be an opportunity to restructure the United States retirement and healthcare systems – we think that will likely be a catalyst to begin to address deficits.”

He also pointed to the fact that relative to other major developed nations, the US has noticeably lower income tax rates and it could therefore be a tool in the future to get their debt situation “back on a more reasonable trajectory”.

He said this ability is one example of how “the U.S. may have a bit more flexibility than some investors may appreciate”.

Not an extreme fiscal picture

While Ivascyn concedes the US does have higher deficits than usual given the strength of its economy, he argued it benefits from its status as the global reserve currency and military ties.

“It has a very strong military and military partnerships, so a type of connectivity with other countries that should be supportive of demand for US bonds,” he explained.

“If you look throughout economic history, benchmark other nations that had high debt levels coming out of World War One, World War Two, look at debt service requirements during the 1980s, the US fiscal picture isn’t as extreme as it may appear,” he added.

“When you look at other metrics around US debt as a function of the value of national assets and similar proxies, given the strength of the private sector, it also looks more manageable.”

Despite this view, PIMCO has been on the margin more focused on front-end maturities “not because of deficit concerns” but more because Ivascyn said investors need more compensation in longer maturities given elevated debt levels.

That being said, the firm believes the US will have more time to address their debt levels and that taxation will be the most obvious tool, with the funding requirements for its social security program being a potential catalyst.