Don’t dump US Treasury bonds just yet

REPORTS of the demise of US Treasuries are greatly exaggerated. On the contrary, US Treasuries remain attractive safe-haven securities, underpinned by the United States’ privileged hegemonic position in the global financial architecture, its innovative dynamism, and a dearth of credible alternatives.

Those pillars of support will stand regardless of who wins the presidential election in November, or at what pace the Federal Reserve cuts interest rates.

Sure, the relentless rise of the US national debt is a concern for the longer term. The US cannot simply run up budget deficits indefinitely and some investors have grown jittery ahead of the election, worried that neither candidate for the presidency has a convincing plan to address the sustainability of the US federal debt, which reached 124 per cent of gross domestic product in 2023 and is projected to grow to 129 per cent by 2033.

For now, however, such concerns are outweighed by the US’ unique financial status.

The extensive use of Treasuries in global transactions and the US dollar’s position as the world’s reference currency are at the core of a financial arrangement that is deeply embedded in the rest of the world (ROW), and which forms part of what former French president Valerie Giscard d’Estaing called the “exorbitant privilege” accorded to the US.

Under this equilibrium, the ROW owns 28 per cent of the US’ gross debt and 40 per cent of US equities. This system is effectively the ”glue” that sustains the current financial arrangement. The ROW is invested across the capital structure of USA Inc, and would have a lot to lose should the system come unstuck.

This gives the official sector in the ROW a major incentive to hold the existing system together, or at least to reduce its US dependency slowly.

Political tensions may make some foreigners sceptical about investing further in US markets, but the US investment proposition is unmatched. Its leadership in innovation translates into highly attractive equity returns that act as collateral for its debt by giving investors confidence in its tax-raising capacity. No other country enjoys such a combination of liquid, safe assets backed by highly attractive collateral.

Against this backdrop, any weakness in US Treasuries may present buying opportunities. The outcome of the US elections in November will not fundamentally alter the existing equilibrium or the US’ capacity to be a producer of safe assets. Short-term deficit increases look likely whichever candidate wins, and it remains to be seen whether either could achieve smaller deficits over the longer term.

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The wrong US foreign policy could, however, undermine the existing global arrangement.

The sustainability of the US debt depends – until it balances its books – on the country’s ability to maintain its privileged position in the global financial system. In addition, it requires that the ROW create sufficient surpluses and be willing to then transfer them to the US through the purchase of US financial assets.

Yet geopolitical fragmentation and increased demands in the ROW for domestic investments – in infrastructure and green energy – threaten to diminish the surpluses available for funnelling into US markets. This raises the stakes for the strength and stability of the US’ international alliances, which support its central role in the world economic order.

Washington cannot afford to alienate too many countries in the short to medium term when it needs foreign capital to fund its debts, even if it intends to balance the budget in the medium to long term and reduce its reliance on foreign capital to fund its deficits.

Already, the US’ foreign and economic policies are out of kilter. Faced with a frosty US trade stance, China has forged closer ties with the emerging Brics countries (Brazil, Russia, India, China, South Africa, Iran, Egypt, Ethiopia and the United Arab Emirates) and other developing markets, creating a loose trading bloc that is increasingly conducting transactions in non-US dollar currencies.

This eats away at the US dollar’s dominance – an issue that risks growing more serious if other trading partners lose trust in the US.

Despite such longer-term concerns, the US remains an investment beacon.

The current global financial arrangement effectively underpins US equities. The US knows its rivalry with China is existential and that to retain its privileged position it needs to remain a leader in innovation. It is doing that, with its microchip investments dwarfing those of its rivals.

Such dynamism helps the US generate superior equity returns, making it a safer borrower and securing Treasuries’ safe-haven status – for now, at least.

The writer is head of the Pictet Research Institute