Navigating the New Normal: Central Banks' Debt Concerns and Opportunities in U.S. Treasury Markets

The latest UBS Annual Reserve Manager Survey 2025 has unveiled a stark reality for global central banks: systemic risks tied to U.S. fiscal policies are reshaping investment strategies, even as U.S. Treasury markets remain a cornerstone of reserve holdings. With nearly half of respondents considering U.S. debt restructuring a plausible scenario and 65% questioning the Federal Reserve's independence, the report underscores a fragile equilibrium between risk and reward in fixed income markets. Amid these anxieties, investors must assess whether the yield advantages of U.S. Treasuries outweigh the growing uncertainties—or if diversification into alternative assets is now imperative.

Systemic Risks: A Perfect Storm of Policy Uncertainty

Central banks are not merely reacting to hypothetical debt restructurings. The survey highlights a confluence of concerns:
- Fiscal Policy Sustainability: The MAGA strategy's tariff measures, deregulation, and tax cuts have fueled doubts about U.S. fiscal discipline.
- Economic Data Quality: 47% of respondents anticipate a decline in the reliability of U.S. economic metrics, complicating forecasting.
- Geopolitical Friction: Trade conflicts rank as the top risk (74%), with fears of protectionism destabilizing global capital flows.

The erosion of confidence in U.S. policy frameworks is further reflected in the 31% of respondents who now see a heightened probability of a global recession—double the rate from 2024. These factors amplify systemic risks, as central banks grapple with how prolonged high inflation (now expected to stay between 2-4%) and elevated interest rates will strain debt servicing.

Yield Advantages: Treasuries as a High-Rate Anchor

Despite the risks, U.S. Treasury markets retain their allure. The survey reveals that 80% of central banks still see the dollar as the dominant reserve currency, driven by Treasuries' unparalleled liquidity and depth. Key yield advantages include:
1. Fed Funds Rate Stability: Over 80% of respondents expect the Fed's key rate to stay between 3-4% for the next year, offering predictable returns for short-term Treasuries.

1. Inflation Hedge Potential: While inflation may moderate, the 40% forecast for 3-4% inflation aligns with intermediate-term Treasury yields, preserving real returns.
2. Safe-Haven Demand: In volatile markets, Treasuries' risk-off appeal remains unmatched.

Diversification: Mitigating Risk Through Alternatives

Central banks are not abandoning Treasuries but are hedging bets. The survey points to three trends:
- Emerging Market Bonds: 47% of respondents are increasing allocations to EM debt, attracted by higher yields (e.g., Brazil's 10-year bonds at ~12% vs. U.S. 10-year at ~4%).

• Green Bonds and Gold: These assets, favored for their risk-adjusted returns and ESG alignment, now account for 15% of average portfolios.
• Currency Diversification: The euro and renminbi are gaining traction, with 29% of respondents reducing dollar exposure.

Investment Strategy: Balance Caution with Opportunism

For investors, the path forward requires balancing yield-seeking with risk mitigation:
1. Core Holdings in Treasuries: Prioritize short- to intermediate-term maturities (2-5 years) to capitalize on stable rates while limiting duration risk.
2. Selective EM Exposure: Allocate 5-10% to high-yield EM bonds with strong fundamentals (e.g., Mexico, Poland) to diversify income streams.
3. Hedging with Alternatives: Use gold (target: 3-5% of portfolio) and green bonds to offset geopolitical and inflationary tail risks.

Conclusion: The Dollar's Dominance, but Not Immortality

While the U.S. Treasury market remains the bedrock of global reserves, the UBS survey signals a seismic shift in how central banks view risk. The combination of high yields and systemic vulnerabilities demands a nuanced approach. Investors should lean into Treasuries for stability but pair them with strategic allocations to alternatives. As one respondent noted, “Treasuries are the anchor, but the ship needs ballast to stay afloat.” In this new normal, opportunity lies in the balance.