Treasuries: The New Risk Assets in a Volatile Landscape

In a recent analysis, Franklin Templeton’s Fixed Income CIO Sonal Desai warns that U.S. Treasuries are now acting as risk assets, a stark departure from their traditional safe-haven status. With yields under pressure from fiscal and monetary policy shifts, investors must reassess their fixed-income strategies to navigate this evolving landscape.

Why Treasuries Are Risky Now

The conventional wisdom that Treasuries are low-risk investments is being challenged. Franklin Templeton’s 2025 outlook highlights three critical factors driving this shift:
1. Fiscal Policy Uncertainty: President-elect Trump’s proposed agenda—including protectionist tariffs, immigration reforms, and infrastructure spending—could expand the federal budget deficit. Increased Treasury issuance to fund these policies would likely push yields higher.
2. Inflationary Pressures: Tariffs and supply chain disruptions are reigniting inflation concerns. The Federal Reserve has already signaled a slower rate-cutting cycle, with the 10-year Treasury yield projected to rise above 4.5% by year-end 1025, potentially breaching 5% if fiscal deficits balloon.
3. Market Volatility: Treasuries’ duration risk is now front and center. As yields swing sharply with policy debates and Fed communications, investors face capital losses if they hold long-dated maturities.

The Yield Outlook and Policy Crossroads

Franklin Templeton’s analysis anticipates the 10-year Treasury yield will remain within a 4.5%-5% range, but this hinges on two key variables:
- Policy Progress: Breakthroughs on deregulation or tax reform could lift growth expectations, pushing yields toward 5%. Conversely, delays in fiscal discipline or unresolved entitlement reforms might keep yields closer to 4.75%.
- Inflation Dynamics: The Fed’s focus on price stability may limit further easing, even if growth slows. Markets have already priced in two rate cuts, a stance Desai calls overly optimistic given persistent inflation risks.

Investment Implications: Tactical Over Static

Desai urges investors to adopt a tactical approach to Treasury exposure:
- Duration Management: Avoid long-dated bonds and focus on shorter maturities to mitigate interest rate risk.
- Security Selection: Prioritize high-quality credits in corporates and municipals to offset Treasury volatility. Franklin Templeton notes that municipal bonds, with 15 consecutive quarters of net rating upgrades, offer a tax-advantaged alternative.
- Sector Diversification: Allocate to floating-rate loans or structured products (e.g., agency MBS) to benefit from improving fundamentals while reducing reliance on Treasuries.

Risks on the Horizon

While Treasuries’ risk profile has shifted, other sectors face challenges too:
- High-Yield Corporates: Tight spreads (near 20-year lows) leave little room for error. Franklin Templeton recommends moving up in credit quality to avoid widening spreads.
- Emerging Markets: EM local-currency debt remains vulnerable to U.S. policy uncertainty and currency fluctuations. Focus on hard-currency bonds and higher-rated issuers (B/single-C tiers).
- Investment-Grade Bonds: With spreads near record lows, these offer limited downside protection. Short maturities and high-quality issuers are safer bets.

Conclusion: A New Era for Fixed Income

Franklin Templeton’s analysis underscores a pivotal moment for fixed-income investors. With Treasuries now exhibiting risk-asset characteristics, the traditional 60/40 portfolio must evolve. Key takeaways:
- Yield Projections: The 10-year Treasury yield could hit 5% by mid-2025 if fiscal deficits expand, making duration exposure perilous for passive holders.
- Policy Outcomes: Success on tax reform and entitlements could stabilize yields, but delays or inflation surprises will amplify volatility.
- Strategic Shifts: Active management, sector diversification, and credit discipline are critical. Franklin Templeton’s recommended allocations—such as 40% agency MBS, 20% municipals, and 15% high-quality corporates—aim to balance income and risk.

In a world where Treasuries are no longer “risk-free,” investors must adapt. As Desai notes, pessimism is premature, but complacency is perilous. The path forward demands vigilance, flexibility, and a willingness to rethink old assumptions.

Data sources: Franklin Templeton 2025 Fixed Income Outlook, Federal Reserve Economic Projections, Bloomberg. All yield figures and policy assumptions are illustrative and subject to change.