U.S. Treasuries No Longer a Safe Bet, Research Indicates by Reuters

By Ann Saphir and Howard Schneider

JACKSON HOLE, Wyoming – The perception of U.S. Treasuries as the ultimate “safe haven” investments is being reconsidered in light of recent research, which suggests that these securities might not be significantly safer than bonds issued by Germany, Britain, France, or large corporations.

This insight emerged from a study presented at the Kansas City Federal Reserve’s annual research conference in Jackson Hole. The research analyzes a change in investor behavior during the COVID-19 pandemic, raising concerns about the “exorbitant privilege” the U.S. government has long enjoyed regarding global borrowing, especially amid increasing federal budget deficits expected to persist regardless of the upcoming presidential election.

The study, conducted by researchers from New York University, London Business School, and Stanford University, also challenges the notion that the Treasury market was dysfunctional during the pandemic, which was suggested by the Federal Reserve in response to its bond purchasing program. The researchers argue that the market was rationally pricing in the risks associated with unplanned government spending initiations prompted by the health crisis.

According to the researchers, “In response to COVID, U.S. Treasury investors seem to have shifted to the risky debt model when pricing Treasurys.” They emphasize the need for policymakers, including central banks, to consider this shift when evaluating the proper functioning of bond markets.

The analysis examines the behavior of Treasury securities during the 2020 pandemic shutdown, a period when yields surged not only for U.S. debt but also for global bonds. Unlike previous episodes of financial strain, when investors typically flocked to Treasuries, this time, they marked down Treasury securities similarly to how they assessed bonds from other countries.

In response to the spike in Treasury yields, the Federal Reserve attempted to restore stability by purchasing bonds, mimicking actions it took during the Global Financial Crisis. The researchers remark, “In the risky debt regime, valuations will respond to government spending shocks, which may involve large yield changes in bond markets,” highlighting especially notable market shifts on days when fiscal stimulus announcements were made.

They warn that central banks’ large-scale asset purchases in response to government spending increases can have negative implications for public finance, arguing that while these purchases provide temporary price support, they can ultimately harm taxpayers by benefiting bondholders and may lead governments to misjudge their real fiscal capacity.

However, the paper faced criticism from various attendees at the conference, including officials from the U.S. Treasury, who argued that it didn’t adequately account for the unpredictability introduced by the pandemic. They pointed out that significant fiscal measures, including the Cares Act’s funding, were effectively financed without issues and observed that U.S. bond yields had recently declined despite ongoing large deficits.

U.S. Treasury Under Secretary for Domestic Finance Nellie Liang emphasized that the findings failed to reflect the uncertainties surrounding the period, citing the substantial debt incurred during the Cares Act without signs of distress during the early pandemic months.