U.S. Debt To Lose Risk-Free Status? Unprecedented Shift Coming | Komal Sri-Kumar

You are going to see the equities which rallied yesterday and today, they are going to tank again in a big way. I was taught to believe that the US is a risk free country. Every other country yield is calibrated with respect to a zero risk country. You thought you will get interest for the next six months, I'm going to move you into a zero coupon bond for 10 years. Those kinds of statements coming from his advisors have introduced an element of sovereign risk into US paper. Treasury yields are inching towards 5%. Is the treasury market signaling higher inflation, higher growth, or none of the above? All of the above. We'll find out what's next for economic growth and Federal Reserve monetary policy with our guest, Kumar Sreekumar, who is the president of Sreekumar Global Strategies. We'll be talking about his views and you can check out his last interview with me, link down below, when we talked about what would happen right after a Fed FOMC meeting. Sreekumar, it's good to see you back. Welcome back to the show. Good to be with you, David. I enjoyed our discussion last time and look forward to this time. Absolutely. Enjoyed having you on and enjoy having you back now. Let's talk about some recent news. It was interesting because up until basically yesterday, President Donald Trump has been steadily wrapping up his rhetoric against FOMC President Jerome Powell, Chair, rather. Now, two days ago, he wrote on Truth Social that Fed Chair Powell was a major loser for not cutting interest rates anytime soon and that if he doesn't cut interest rates, the economy may see some trouble. Major slowdown, I think he said. Now, just the day after, which was yesterday, things changed 180 degrees. He was asked, President Trump was asked, will he fire or does he intend to fire Chair Powell? And he said, no, none whatsoever, were his words at the Oval Office. Why do you think that there's a sudden change within a span of one day? The change came because of the market reaction in the United States to what he had said about Powell, calling him a major loser and suggesting that the president couldn't wait to see him gone from the job meant that there was going to be a lot of instability in the markets. The bond market in particular was concerned that Trump may try to fire him and news reports suggested that he had met, the president had met with his closest advisors in terms of finding out what is the legal loophole he can use in order to fire the chairman. All of that essentially destabilized the markets. And we saw the yield shoot up. We saw the gold price rise by more than 100 US dollars per ounce. And clearly, the president backtracked and he could not stick with that position. And therefore, he said now the latest move, I never threatened to number one. And going with that, David, is the statement that he really doesn't mean to put a hundred and forty five percent tariff on the Chinese and that he would indeed be doing it much lower level than that. The key point to keep in mind in all of this is that the Chinese authorities have not made any concession to Trump at all. He suggested hundred and forty five percent. The Chinese response was hundred and twenty five percent, saying that tariff is sufficient because there's not going to be any demand for US products, anything at all at hundred and twenty five percent tariff. Now the president comes back and he says, well, I'm going to pull down the tariffs and I'm not going to do that. So if the Chinese were watching, they are going to suggest that here is somebody who threatens big time, but he doesn't carry it out. And so he pulls back. And that is not a very good strategy for a negotiator. Yeah. And speaking of what people have been talking about behind closed doors, this is Treasury Secretary Scott Besson saying that in a private speech apparently in Washington for JPMorgan Chase, Besson cautioned that talks between the US and China had yet to formally start. President Donald Trump placed import taxes at hundred forty five percent, like you said, on China, countered with one twenty five. It went up to as high as two forty five on some goods. But anyway, broad based tariffs, one forty five percent. Besson had said that he is open to negotiating now with China. I Besson said neither side thinks the status quo is sustainable. This article is making it look like in the headline that he's saying the trade war is not sustainable. He's saying that neither side thinks the status quo is sustainable. First of all, is he right? Before we talk about negotiations with China, let's talk about whether or not this statement is correct that the trade war at one hundred forty five percent on China, one hundred twenty five percent on the US is not sustainable. What does that mean? That it's not sustainable. When he said it is not sustainable, he meant to say that it is not sustainable in terms of global growth, in terms of the adverse impact it would have on overall trade. But what I think both Trump and Besson really mean to tell you is that it is not sustainable from a market viewpoint. That is what is most important to them. They can live with a recession. They can live with slower economic growth, but they cannot live with a situation where the 10 year treasury yield goes up to five percent or higher and in a situation in which the equities continue to crash. That is something it is intolerable for the administration. And I think that's what came out in the statements. But let's extend what you said, David, and go a bit further. Scott Besson, after having said that there is going to be a de-escalation and which is what caused the rally in the markets, a massive rally earlier on Wednesday, he later on said it may take two to three years in order to reach an agreement. It's not going to be a simple solution. That's the first thing. The second point that Besson made is that Trump has not unilaterally made concessions to Chinese authorities. Think about what that means. If the US has not made any concessions to begin with, the Chinese, who are very proud in their own right, they are not going to come and make the first set of concessions. So it's going to be a tug of war to see whether you concede first or I have to concede first. And how do we interpret that, that you backed off or I backed off? So far, it appears as if what Trump has done is that he has backed off both with respect to power and with respect to trade tariffs. And the whole world is watching this happen. And that's why I said this is not a good sign in terms of what it means for US negotiating power. So let's assume, for the sake of argument, that nothing changes. We continue to have 145% tariffs on China and 125% tariffs on the US from China. What happens to markets over the long term? If that happens, let's assume I'm going to stay with you, David, and assume for the next two years, it's 145% on the Chinese and 125% on the United States. Nothing changes there. If that is what we have, you are going to see the equities which rallied yesterday and today, they are going to tank again in a big way. Second, you're going to have a situation when the 10-year Treasury yield rises. And why does it rise? You mentioned two factors at the beginning of your introductory remarks. One, you said it is because of real growth expectation. The second is inflationary expectation. But a third element has entered, and it is very new for me. It is very new for the United States. Ever since I was a graduate student, I was taught to believe that the US is a risk-free country. Every other country's yield is calibrated with respect to a zero-risk country. Now, because of the statements that Trump has made, and some of the discussions they have had, which are broadly known as Mar-a-Lago Accord, which essentially says, hey, you bought six-month Treasury bills. I'm now going to restructure your debt into 10-year debt. Or I might even do something else. You thought you will get interest for the next six months. I'm going to move you into a zero-coupon bond for 10 years, which means that that's not what you intended to buy. And any of those kinds of statements coming from his advisors have introduced an element of sovereign risk into US paper. And that is a new development. That's what they need to be very concerned about. Is the US debt still risk-free? Here's an article from Yahoo Finance. Another US debt downgrade warning from S&P Global Ratings. The outcome of the US government's budget process and policy negotiations over the coming months will help determine policies that inform our view of US sovereign credit worthiness. They're not downgrading it yet, but this statement is being interpreted by some as a potential for a downgrade this summer. So can you comment on this and my broader question as to whether or not, per your studies in grad school and everybody else for that matter, is US debt still risk-free? I would say that if the president completely backs off and essentially says there is no movement to restructure the US debt and he's going to come down on the tariff side, he's not going to touch on monetary policy or even comment about what Powell is doing. If he does all of that, and he has a limited amount of time, if he does that, let's say, within the next month, you can say that the US has gone back to risk-free status. But I don't think any of those is likely to occur. So we are moving toward a new situation, what an author might have called a brave new world, where we have to deal with the United States as a country which has risk in itself. Okay. We're not talking about, obviously, junk bond status, but it could be something along the lines of maybe double A instead of triple A, that kind of reality? Yeah, that is correct. Keep in mind that S&P downgraded the United States in August of 2011. So we are talking about something that happened 14 years ago, because of the level of debt and the country not doing very much about it. So if there is a downgrade, I don't think it will go to non-investment grade. We are still going to be, let's say, pick a number, A plus, rather than anything lower than that. But that means that A plus has to pay a higher yield than a double A country or a triple A country. And that means interest rate expenses would go up even more, perhaps even, yeah, threatening the treasury even more. Exactly. At a time at which they have to reduce the interest payments in order to reduce the fiscal deficit. But then look at how they can do it. They cannot do it by restructuring the debt. You have to do it by cutting spending. And that they wouldn't be willing to do now. But Sree, let's suppose, going back to our earlier discussion about tariffs, let's suppose tariffs don't come down anytime soon. What you're saying about the market crashing, OK, that's a reasonable expectation. But wouldn't markets eventually adjust? Companies would then just have to adjust their business model for, I guess, barriers of entry to trade, shall we say, or just barriers of trade overall. Eventually, the stock market would grind higher on, I guess, new business strategies, would they not? Yes. But think about what the implication of your statement is, though. Let's start with the market valuation. Let's pick a number of 20 times earnings for the S&P. If rejiggering your business and making sure that you're able to produce and export to new countries, that your inputs are going to be much more expensive, that you, when you run your firm, you are adjusting to it. What that means is, you bring your price down to 12 times EPS rather than 20 times, let's say. So if the price multiple has come down substantially to validate the new economic structure, that involves a big decline in equity prices. Only then can it start to correct and start to move up again. Okay. And what then is your base case assumption for what will happen to, I guess, negotiations, trade war results over the course of this year, perhaps into next year? Ultimately, we as investors want to know what will happen to the markets. I think what will happen to the market eventually, and there is, again, a time element involved, and it's a question of how long it takes. The process that I see is that Trump then backs off, and he's the one who backs off and does it unilaterally. Not China, not the European Union that come and do it, but then he does it first. And then they make token reductions in their tariffs, and the United States declares it a victory. Oh, we won because our tariff negotiation strategy turned out to be a big success. So you declare victory and move on. And if you do that, and you set your tariffs at a new level, the markets, as you said before, will adjust to it, maybe at a lower level, but we get ready to move up again, and to attract capital coming in. That involves one very important requirement. You cannot keep changing policy week after week after week, as the United States has been doing. You don't know what policy to adjust to if you're a manufacturer or you're a multinational company. If you do not do that, then you have a good future on that and a good future for the equity market. Let's talk about what's going to happen now to Federal Reserve monetary policy. Here is a CMH FedWatch tool, 94% of no change by May 7th, the next FOMC meeting per the bond markets. Now, you previously told me, I believe, I'm paraphrasing here, but that the Fed will not cut rates unless something breaks. Well, I guess this is the market's way of saying nothing's broken yet. Is that correct? This is the market where nothing is broken yet. That is correct. But again, May 6th and 7th, they are going to meet the Federal Open Market Committee. And if you find signs of inflation not picking up, and then the jobs report for the month of April, which will come out just about the time the Fed is meeting, if that report suggests again, job creation has just fallen off, and the unemployment rate has risen significantly from the 4.1 range. If it goes to 4.5 or 4.6 because of layoffs, then that is when I would say this is something has started to break already. The consensus is that economic growth will slow either way. In fact, the Atlanta Fed GDP Now tracker is projecting negative growth for next quarter. Why do you think the Federal Reserve, to Donald Trump's point, why do you think the Federal Reserve is not cutting rates now in anticipation of a slowdown? I mean, he doesn't want to be Mr. Too Late per Trump, right? Right. Why doesn't the Fed cut? Because they have two elements in their mandate. You mentioned one of them, economic growth and jobs. The second part of the mandate is inflation. And so clearly what the Federal Reserve is thinking, and I think they are correct in that, they are thinking these tariffs are going to be highly inflationary. And if you can imagine a conversation between Trump and Powell, it would go like this. Powell says, Mr. President, you want me to cut interest rates. But I cannot do that because your tariff policy is pushing up inflationary expectations. And keep in mind, that's roughly what he said the day before Trump got very angry and called him a major loser. And the reason was Trump had said the tariffs are increasing inflationary expectations. So that has to change before the Fed will give up or something has to break. Well, let's take a look at economic growth forecast and ultimately your growth forecast. This is from the IMF. The IMF is warning of rising US recession risks. The US is confronting an increased risk of recession as Trump's trade war pushes the global economy into a significant slowdown, the IMF warned, with the fund's top economists defending the Federal Reserve's policy on interest rates. Countries needed to urgently resolve their trade tensions to avoid further damage to growth prospects, the fund said. If sustained, this abrupt increase in tariffs and attendant uncertainty will significantly slow global growth. Let's take this one step at a time. Do you agree with this statement? I agree with the International Monetary Fund statement that economic growth is going to slow significantly as a result of the trade tensions. There's little to no doubt about that taking place. The doubt is only how long will the trade tensions last? And do we just stop fighting and go back to the old days before January 20th? Why would you think the IMF is defending the Fed's policy to stay put when growth is going to stagnate? I guess they're also assuming that inflation will take up, which is not being reported here. Well, at least not what I've read so far. Right. That is the reason why the International Monetary Fund is supporting the Fed. There are two reasons. One reason is economic. The second reason is political. The economic reason is, as you said, there is also an inflation expectation coming and inflation is likely to pick up. And therefore, the Fed says we as an organization always want to maintain manageably slow inflation. Therefore, we support the Fed, which is trying to keep the inflation low. That's the economic reason. What is your outlook on inflation? I bring this up because it's relevant to our understanding of how tariffs impact inflation. This is the BLSCPI chart. Let me just show my screen. And proponents of Trump's policies will point to the fact that when he was in office the first time, tariffs were implemented as well and the didn't change dramatically on tariffs. We saw inflation hover between 1.5 to 2.9% at the highest point before COVID happened. So if history repeats itself, there should be no significant change in the CPI this time. There are two differences. One, in the 2019 instance that you mentioned, we were coming off a period of extremely low inflation. Keep in mind that in the aftermath of the Lehman Brothers failure and the financial crisis of September 2008, the world was dealing with a situation when the Fed was trying to see how to push up the inflation rate. Because it was so low, they were afraid that very low inflation rate in turn could at some point push the economy into deflation. Now, that changed not only with COVID, it changed with the Federal Reserve doubling the balance sheet between 2020 and 2022. They cut interest rates to practically to zero, kept it there for a long period of time through 2021. When it was clear the economy was recovering, but the Fed continued to keep the interest rates very low. That's why inflation perked up so substantially. You had a joint effort by both the Fed and the Treasury to stimulate the economy. That stimulus in turn meant that the Treasury deficit increased substantially, and the fiscal deficit and the monetary policy problems, it was like a double barrel cannon that was shooting out and the prices went up. That's why you're not able to take the same position with tariffs today as you may have taken in 2019, because you start out with a much higher level of inflation than you did in 2017 and 2018. Interesting. I'm curious to get your personal outlook on inflation, given that tariffs, like you mentioned this time around, may be more inflationary than last. However, if we do enter some sort of economic slowdown or even a recession, recessions are inherently disinflationary, if not deflationary events. How do we balance that, tariffs being inflationary and a slowdown being deflationary? This is the way you square things. I'm not looking for a recession, in which case what you said would be true. Namely, inflation would slow down and Treasuries will become very attractive and equities will lose attractiveness. All of them are characteristics of a recession. What we are heading toward, I think, is a stagflation, which is very rare. The last time we had was in the late 1970s and early 1980s. That was the start of my career when I watched that. When you are in a stagflation, inflation continues to remain high, even as the economy goes into a recession. What happens then is that bond yields go up and equity prices come down, which means you are a loser two different ways, both in the bond market and in the equity market. It's very rare. That's why I think what looks forward is a different situation from what we had in the past. That's what happened in 2022, by the way, when yields rose and stocks fell. The 60-40 portfolio didn't work. Which kind of assets will do well during a stagflationary environment? One that would work very well would be if you say, where should you be hiding? Where should you go and put your cash? You can hide in short dated, highly rated instruments. You can go into three-month, six-month treasury bills. They don't carry a duration risk and you get a decent relative return. If the world goes to hell in a handbasket, then the price of gold is going to once again resume its rise. Remember that two days ago, it went up by $125 in a single day, which has never happened before. You can go and hide with part of your portfolio being in gold, part of your portfolio being in short dated treasuries. Third area which would be very helpful would be alternative investments. For example, I've been talking about well-managed real estate and you give a good manager money to hold on your behalf for five years or seven years and you're not watching the net asset value of the fund on a daily basis and you are waiting for the markets to recover and for you to make money in five years or seven years, that's another way to be able to hide and protect the bulk of your assets. You're talking about residential real estate? I'm talking about residential real estate. I'm also talking about distress. The distress comes, for instance, with commercial real estate and many US cities, we have a problem with office buildings which have changed hands at 40 to 50 percent of the price at which they change hands in 2019. 2019 is considered like the peak just before COVID. And right now, if you change hands, what you paid $100 million to buy a building, you may be able to sell it for $40 or $50 million. So you've lost a big chunk of change. That may be a good attractive opportunity if you think that based on the calculation of the real estate manager, the location is a good one, $40 million for a $100 million building. It's a very good price and it's going to come up again in price. You warned about the dangers of commercial real estate back in December 2024. Can you walk us through your sentiment for commercial real estate sector now? The sentiment is somewhat improving. I think 2024 was about the worst. What we find taking place in the months of 2024, as well as continuing in 2025, is that transactions have picked up. So what that means is that rather than decide that the price that you paid is eventually what the market is going to come back to, holders are realizing that the markets are not going to come back to the 2019 level. And therefore, they are willing to sell. And therefore, there's an opportunity in commercial real estate in a way that did not exist one year ago, because the market then was totally stuck. It was glued and there were no transactions and the transaction level has since picked up. Transaction levels have also picked up for another reason, namely, that the banks which were able to do something called extend and pretend, when you borrow from me and I decide that even though you can't make any payment, I'm simply going to extend the period of your loan. And I'm going to put it on my book saying he's going to pay me back next year. And they've done that for a couple of years. And I think 2025, reality is setting in. And many of them are trying to sell those assets. That's also causing more transactions in the commercial real estate market. So if you were to evaluate the safe havenness, worthiness, I guess, of these following assets, treasuries, gold, real estate, Bitcoin, which of these would would rank the top in your list? The top would be the top would be gold, again, in terms of where to hide. And second would be short dated treasuries, keeping that in mind. David, when I say that, I'm assuming none of the strange ideas coming from the Mar-a-Lago Accord will be implemented. You do not want them to restructure your six-month treasury bills into 10-year obligations, for instance. If nothing like that is done, short dated bills would again be a good safe haven. So those would be two areas. And then look at commodities. There are some commodities which are going to benefit when inflation picks up. And that would be a place to go. For example, oil prices fallen substantially. At some point soon, that's going to be a buy. At what point? $50, $45 a barrel? To pick a number, probably $50 for Brent crude. So that would be lower than where we are today, but we are not too far away from it. Is there any price for gold at which it stops becoming attractive? Yes. It stops becoming attractive if the price just shoots up substantially, and we have gone up to $3,500 per ounce. We started just a few months ago at about $2,600. So we have come a long way. The second way in which gold loses is, keep in mind, gold does not provide you with any income. You're just holding on to it in your box and waiting for the price to go up. If the competing yield on bonds is much higher, if the US treasury yield goes to 5%, for instance, or 5.5% to borrow for 10 years, that will also hit gold. Because the more you get from treasuries, the more you're losing by holding it in the form of gold. Okay. What about emerging market assets or even just any non-US denominated assets? So last week, as you recall, there was a bit of a scare as investors saw the yields rising, as well as a dollar falling, which may have signaled a flight of capital outside the US or towards other places. First of all, was that the case that people pulled money out of the US? And if so, which other places outside the US should we look to? It is true that they pulled money out of the United States, but I don't think that money rushed into emerging markets. Look at what happened to the price of gold. It went into gold in a big way. And I think hiding the safe haven was the ultimate safe haven in terms of gold, which was where the money went into. As far as where the money went out of, the rise in the price of gold tells me that you have a flight from currencies in general. So it's not as if you left the dollar to go to the euro. That happened a bit because you went from $1.11 to $1.14 per euro. That means that the euro strengthened with respect to the dollar, but not as much as what happened to gold. So when you have people who are afraid of keeping it in paper dollars, afraid of keeping it in paper euros or yen, then the gold becomes the single biggest beneficiary of those circumstances. Take a look at my screen. This is the DXY. So just a few questions on this one. First for just the average American watching this, they're probably not traveling abroad and so they don't have to worry about their dollar losing purchasing power in other places. But should the average American be concerned about this chart, the DXY falling from almost $110 just a few months ago, now down to just under $100? It's a big move. Do we have to be concerned about our purchasing power decreasing because of the dollar going down? They have to be concerned for two reasons. One reason is, as you mentioned, that the purchasing power of Americans seen on a global basis has diminished. If the DXY goes from $106, $107 to below $100, clearly that is a big loss of purchasing power. You also need to be concerned because you want to see why the price of DXY went down. And it went down not because other countries were growing rapidly and they were increasing their exports to the United States. On the other hand, DXY went down because the dollar was being actively undermined by the Trump policies. Namely, they were talking about trying to the dollar cheaper. They were trying to prevent the US yield from going up by restructuring the debt. All of those made the dollar go down because there was a flight from the currency. That is a negative reason or not a good reason why the dollar weakened. Okay. Would you be a buyer of the dollar versus another currency pair at current levels? Depends on what currency you're looking for. If you have a currency portfolio, it might make sense for you to have a significant portion in US dollars because it is still the biggest market and the currency that everybody trades in still compared with the others. So you need to have it. But compared with where you were even three or six months ago, the expectation would be that you reduce your weight in dollars as a result of the recent developments. Excellent. So finally, let's end on your asset allocation overweights and underweights given everything we've discussed so far. My asset allocation, again, I would say for the next two or three months, if you talk to me in three months, it'll be different because the markets will be different. Absolutely. For the next few months, I would say underweight the United States, overweight the rest of the world. You'll probably be close to market weight in emerging markets, but overweight with respect to Japan and Europe. That's where your overweight is coming from when you take money out of the United States equities. Be overweight in terms of short dated fixed income instruments of a high grade and be low weighted in duration risk. In other words, what you buy for 10 years or 30 years or buy municipal bonds which don't mature for 30 years, be very careful because you're running a duration risk. And again, we talked about real estate, allow for some part of your portfolio to be outside of the 60-40 calculations and give good alternative investments, a chunk of your portfolio as well. Okay. Excellent. Thank you very much, Sri. Let's follow up again in a few months. Surely the markets will have changed by then. We'll talk about a different view. Where can people follow your work in the meantime? In fact, I have something called sreekonomics.substack.com where I put my reports out every Saturday and I have quite enough. My following is not as big as yours, David, but I do have a decent amount of people who read it every weekend. That is one place to do it. And whenever I write something, I also post it on Twitter. And that is at Sreek Global, S R I K and then global. That's the handle. And that's another way to follow. Well, my following is big only because we have great guests like you come on the show on a regular basis. So thank you for being here. And please do follow Sreekonomics in the link down below. Thank you very much, Dr. Sri. We'll speak soon. Take care. Thank you, David. Very much a pleasure to speak with you as always. Thank you. And thank you for watching. Don't forget to like and subscribe.