US Treasury Bonds Face New Scrutiny: Are They Still the Ultimate Safe Haven?

The safety of U.S. Treasury bonds might not be significantly higher than that of German, British, or French bonds. Traditionally touted as the "ultimate safe haven" in global markets, U.S. Treasury bonds have seen their reputation put into question in recent years, especially following the COVID-19 pandemic. This perspective was highlighted by a recent paper presented at the global central banking conference in Jackson Hole, Wyoming. The paper, titled "Government Debt in Mature Markets: Safe or Risky?", authored by Stanford University Professor Hanno Lustig among others, explores the shift in investor behavior towards U.S. Treasuries during the pandemic. It suggests that investors have started pricing U.S. Treasuries using a model associated with riskier debts, challenging the long-held "exorbitant privilege" of the U.S. government. The research indicates that during the COVID-19 lockdowns of 2020, Treasury yields surged, a trend also observed with bonds issued by other countries around the world. Contrary to past financial crises, investors did not flock to U.S. Treasuries as a safe asset; instead, they devalued them alongside other sovereign debts. This change in behavior led to a significant depreciation in U.S. bond prices, mirroring global trends. The Federal Reserve's response to the spike in Treasury yields, which included purchasing bonds to restore market order, was reminiscent of measures taken during the global financial crisis. The study emphasizes that the valuation shifts, driven by the large-scale fiscal stimulus measures, caused notable market volatility. It noted that extensive asset purchases by central banks in response to sizeable government spending impacted public finances negatively, offering temporary price support while undermining taxpayer interests and encouraging the government to overestimate its fiscal capacity. The paper has sparked controversy, facing opposition from U.S. Treasury officials and some conference attendees. Critics argue that the paper overlooks the uncertainty brought about by the pandemic and the robust performance of fiscal interventions, which have not yet posed significant problems. Nevertheless, the debate highlights the persistent concerns over the safety of U.S. debt. As of the end of last month, the U.S. national debt has reached a historic $35 trillion. This raises broader issues about international financial stability, as pointed out by officials like Switzerland's Finance Minister Karin Keller-Sutter, who warned that high debt levels in the U.S. and Europe pose risks to global financial stability. Looking ahead, the discussion on U.S. debt security will likely remain a focal point for policymakers and investors, especially with ongoing fiscal deficits and rising debt levels. The recent findings signal that U.S. Treasury bonds may no longer be seen as the unparalleled safe asset they once were, urging a reevaluation of their role in global portfolios.