In all markets and currencies traded, the US Treasury bond – Treasuries – has a significant impact. In finance, any measure of risk is relative, meaning that if someone insures a house, the maximum liability is set in some form of money.
Similarly, if a loan is obtained from a bank, the lender must calculate the probability of not returning the money and the risk of the amount falling due to inflation.
In the worst case scenario, let’s imagine what happens to the cost of issuing debt if the US government temporarily suspends payments to certain regions or countries. Foreign companies currently hold more than $7.6 trillion in bonds, and many banks and governments depend on this cash flow.
The potential cascading effect from countries and financial institutions will immediately affect their ability to regulate imports and exports, leading to even more carnage in credit markets as each participant rushes to reduce risk.
More than $24 trillion in U.S. Treasury bills are available to the public, so participants generally assume that the least risk that exists is government-backed debt securities.
The return on the treasury is nominal, so take inflation into account
Highly publicized yields are not what professional investors trade because every bond has a price. But based on the contract’s maturity date, traders can calculate an equivalent annual return, making it easier for the general public to understand the benefits of owning a bond. For example, buying 10-year US Treasury bonds at 90 tempts the holder with a 4% yield to maturity.
The interest rate on US government bonds over 10 years. Source: TradingView
If an investor believes that inflation cannot be kept down anytime soon, these participants tend to demand higher returns when trading 10-year bonds. On the other hand, if other governments face bankruptcy or their currencies are overinflated, these investors are more likely to seek refuge in US Treasuries.
The fragile balance sheet allows US Treasuries to sell less than competing assets and even fall below expected inflation. Although unimaginable a few years ago, negative yields have become very common after central banks cut interest rates to zero to stimulate their economies in 2020 and 2021.
Investors pay for the privilege of receiving government bond security rather than taking on the risk of bank deposits. As crazy as it sounds, there are still more than $2.5 trillion in negative-yielding bonds, and that’s without taking into account the effects of inflation.
Ordinary bonds have a higher inflation price
To understand how far from reality US Treasuries are, you need to understand that the three-year bond yield is 4.38%. Meanwhile, consumer inflation is at 8.3%, so either investors believe the Fed will be able to ease the scale, or they are ready to lose purchasing power relative to the world’s less risky assets.
In recent history, the United States has never defaulted on its debt. Simply put, the debt ceiling is self-limiting. Thus, Congress determines how much debt the federal government can issue.
In comparison, the HSBC Holdings bond due August 2025 is trading at a yield of 5.90%. As such, the US Treasury yield should not be interpreted as a reliable indicator of inflation expectations. Moreover, it matters less that it reached its highest level since 2008, as the data shows that investors are willing to sacrifice profits to retain ownership of less risky assets.
Thus, US Treasuries are an excellent tool for benchmarking corporate and non-corporate debt, but not in absolute terms. These government bonds will reflect inflation expectations, but may also be severely limited if the overall risk to other issuers increases.