Higher Rates Push Both Congress, Investors to Change Strategy

Representatives from both political parties have introduced the Fiscal Commission Act. The bill would establish a 16-member commission charged with proposing bills to reduce the U.S. federal budget deficit and keep the country’s debt-to-GDP ratio less than 100%.

Specifically, the bill would appoint 12 members of Congress (three from each party from each house), as well as four experts from outside Congress (appointed by the party leadership from both houses). The panel would make proposals to Congress by a majority vote, provided at least three appointees from each party approve.

The process of approving the recommendations legislatively would be streamlined: Both chambers would have to vote on any recommendation made by the commission without an opportunity to offer amendments, and a motion to begin debate in the Senate could move forward with a simple majority vote, instead of the 60 votes normally needed.

The bill was proposed by Representatives Bill Huizenga, R-Michigan, and Scott Peters, D-California. Progress on the bill and most other matters in the House of Representatives is currently stalled as the majority Republican Party prepares to nominate a new Speaker of the House, to be elected by the full house.

The proposed legislation comes at a time when total federal debt stands at approximately $33.17 trillion. According to the Federal Reserve, the total debt-to-GDP ratio at the end of 2022 was 119.8%, though this included intra-government debt and debt owed to the Fed itself.

The sensitivity to high federal debt levels and government borrowing is heightened by higher interest rates, which increase the cost of servicing the debt. According to the Department of the Treasury, debt payments consume 15% of total federal spending.

Higher interest rates can also improve returns for investors in government and corporate debt, and they can influence bond and equity investing strategies.

John Croke, the head of active fixed-income product management at Vanguard, says current investor demand for corporate bonds mostly depends on the investors’ time horizon. Long-term investors are “taking advantage of the more attractive levels of yields through rebalancing portfolios to their long-term strategic allocations,” he says, whereas shorter-term investors “have been concentrating their fixed-income exposure in cash, given the attractiveness of very short-term yields, but risk missing out on the diversifying benefit of owning longer-duration, high-quality bonds in the event of an economic or equity market contraction.”

For defined contribution plans, Croke says investment menus are designed to provide options in varying environments and “should not be restructured or re-imagined because we happen to be going through the first meaningful rise in interest rates in 15-plus years.”

For pension plans, Croke adds, “we have seen plan sponsors with disciplined asset-liability strategies take advantage of both higher interest rates and a strong post-COVID equity market to ‘lock in’ funding levels at fairly healthy levels.”

Josh Jamner, a vice president and investment strategy analyst at ClearBridge Investments, says higher Treasury yields can reduce the appeal of equity investing, especially “defensive and growth” equity as opposed to “cyclical and value” equity, which can perform better in a high-interest-rate environment.

He explains that growth and defensive stocks have cash-flow expectations that are more future-oriented and are therefore discounted more against higher rates.