Threatened by a Default, Treasuries Retain a Paradoxical Appeal

Government bonds have been at the center of the debate over the debt ceiling.

For decades they have been viewed as the ultimate safe haven asset, the foundation of the global financial system. But as the deadline for a deal to avoid a U.S. debt default looms, the Treasury bills to be issued in early June have been priced roughly on par with junk bonds.

In the credit default swap market, U.S. Treasuries were suddenly seen as riskier than the government bonds of countries like Mexico, Bulgaria and Greece.

But in the nick of time, President Biden and Chairman Kevin McCarthy reached a deal to suspend the debt ceiling. On Thursday, the Senate gave final approval to a bill that would ensure the Treasury Department doesn’t run out of money.

So the US avoided a formal default after another rough and unsettling situation. What can cautious investors learn from this close call crisis?

Paradoxically, the best answer may be exactly the same as before this crisis. Buy US Treasuries for safety.

This has so far been a proven solution to investment agitation. And it’s probably, but not a certainty, a sure answer to some fundamental investment questions, both now and for the foreseeable future.

Despite countless crises at home and abroad, investors have flocked to the $24 trillion Treasury market whenever they needed refuge.

First, it is the deepest market in the world. Despite the sanctions, tariffs and money laundering regulations imposed by the United States over the past few decades, the US government bond market remains very open and easily accessible by international standards. If you want to buy and sell securities quickly, hassle-free and at low cost, US Treasuries and US Dollars are very good options. No other global asset class offers the same benefits.

The most important feature of U.S. Treasurys is the security and stability that they were clearly vulnerable to during the debt conflict. Government bonds have often been a pain reliever. When all else seems unsafe, you can hide it in a Treasury bond, hold it to maturity, and hope to get your money back.

Even now, the “complete confidence and credibility of the United States” has never been broken. Guaranteed by ConstitutionWith a long history of stability as a rule of law nation, and the combination of economic, military, and political power that has made America unique.

After World War II, if there is anything on this planet that we can count on, it is America’s ability to pay.

But that assumption seems naive every time the U.S. faces a debt ceiling conflict. It never mattered if the country had enough resources. The question is whether the political system works well enough to raise enough money for the US government to continue operating.

Each slump in debt negotiations was resolved without default and ultimately the Treasury market recovered.

Such gains usually occur when a global crisis disrupts capricious stock markets and investors seek a safe haven. If the crisis is abroad, it makes sense to find a way out in U.S. Treasuries. Brexitfor example.

It may seem counter-intuitive to put money into Treasuries during a crisis that originated in the United States, but it has happened many times. That’s the logic of “Ghostbusters”. where else are you going?

Back in 2011, for example, a lingering dispute over the debt ceiling nearly ended in default, leading to Standard & Poor’s downgrading the pure AAA rating of U.S. Treasuries. Nevertheless, US Treasurys rebounded despite being the root of financial market problems.

This time, with the threat of default gone, Treasuries are likely to resume their role as a haven in the storm.

This may sound like an inevitability, but it’s not a certainty.

The cracks revealed in the Treasury bills and credit default swap markets in May are real, and many financial contingency plans include the slim chance of a US default catastrophic event. It was If U.S. politics becomes more difficult and dysfunctional, further downgrades of U.S. Treasuries could occur, and skepticism about the solidity of U.S. Treasurys could still dull its luster. Financial services firms such as Goldman Sachs and MSCI have factored a bear market in Treasuries into their low-probability, high-risk scenario for this crisis.

But for now, the outlook for the Treasury market looks pretty bright. Recall that on May 24, Treasury bills maturing in early June yielded over 7%. This shows that traders are demanding a hefty risk premium to buy treasury bills. Yields dropped to less than 6% after Memorial Day, according to FactSet data. Prices moving in the opposite direction of yields soared. And in the credit default market, insurance prices on Treasury debt have fallen to about one-seventh of their crisis-time peaks.

Beyond the debt ceiling, other factors dominate the bond market. Most important are the Federal Reserve’s long struggle to keep inflation under control by tightening monetary policy, the possibility of a recession, and the pressure on local banks from rising interest rates.

Will the Fed raise short-term interest rates further at its next meeting in June? Traders are now bet I don’t think so. Additionally, many indicators point to an approaching recession.

These factors make the argument for fixed income (high quality corporate and government) very compelling. Bond yields have already risen significantly over the past year, and these yields are fairly good predictors of bond market returns. Consider that if he holds a 1-year treasury bill for 1 year, he can expect a return of 5% or more. This is a high threshold for risky investments. Compared to equities, short-term government bonds are attractive.

This trend is somewhat less pronounced for long-term bonds due to lower yields. In bond market jargon, it’s an inverted yield curve. This suggests that traders are anticipating a recession, when the Fed will be forced to cut short-term interest rates to stimulate the economy.

Recessions are usually bad for most people, and for the stock market, but they tend to be good for Treasuries as investors look for old idle assets and Treasury prices rise when market yields fall. be.

In other words, it has threatened U.S. Treasuries in recent weeks. The risks of holding assets that are not considered risk-free have become all too obvious these days. But with a little luck, Treasuries are likely to come out of the debt crisis again essentially the same way they have been. In a world where nothing is completely safe, Treasuries remain a relatively safe place to deposit money.

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