US Treasuries aren’t the safe bet they once were, research shows

By Ann Saphir and Howard Schneider

JACKSON HOLE, Wyoming (Reuters) – No safer than a package. Or a gold. Or an OAT.

Long touted as the world’s “safe haven” securities, US Treasuries’ behavior during and after the COVID-19 pandemic calls that label into question, suggesting they are little different from debt issued by Germany, Britain, France, or even large corporations.

That’s the key finding of new research presented at the Kansas City Fed’s annual research conference in Jackson Hole, Wyoming. It examines a shift in investor behavior over that period that raises questions about the “exorbitant privilege” the US government has long enjoyed to borrow in the global market, even as federal budget gaps widen more.

It’s a timely question, given that widening deficits are seen as a near certainty regardless of who becomes the next US president.

Roberto Gomez-Cram of New York University, Howard Kung of the London Business School and Hanno Lustig of Stanford University also question the claim that the Treasury market was dysfunctional during that period – as the Federal Reserve then claimed when it launched its massive bond-buying — or just rationally pricing in the risk of a massive unfunded spending shock, then prepared in response to the health emergency.

“In response to COVID, US Treasury investors appear to have shifted to the risky debt model when pricing Treasuries,” wrote Roberto Gomez-Cram of New York University, Howard Kung of the London Business School and Hanno Lustig of the University Stanford. “Policymakers, including central banks, should internalize this shift when assessing whether bond markets are functioning properly.”

The researchers looked at the behavior of government bonds during the 2020 pandemic shutdown, when yields rose not only on US debt but also on bonds issued by nations around the globe.

They found that investors did not, as they had during previous episodes of global financial stress, pile into Treasuries and increase their value. Instead, investors shorted Treasuries, just as they did for bonds in other countries.

Meanwhile, the U.S. Federal Reserve responded to the rise in U.S. Treasury yields as if it were the result of market dislocation, they said, buying bonds to restore order to the world’s most liquid debt market, as it did- o during the global financial crisis.

“In the risky debt regime, valuations will respond to government spending shocks, which can imply large changes in bond market returns,” the researchers said, noting that they found particularly large market movements on days when fiscal stimulus was announced.

The story continues

“In this environment, large-scale asset purchases by central banks in response to a large increase in government spending have undesirable implications for public finances,” they wrote. “These purchases, which provide temporary price support, destroy value for taxpayers but subsidize bondholders” and may also encourage governments to overestimate their true fiscal capacity, they wrote.

push

The paper drew pushback from the public, including Treasury Department officials and others who said it had to take into account the uncertainty surrounding the pandemic, the fact that the hundreds of billions of dollars in fiscal response to the crisis had been funded smoothly, and that more recently US bond yields have fallen even with large deficit spending.

The work did not reflect the “uncertainty in the episode,” U.S. Treasury Undersecretary for Internal Affairs Nellie Liang said in comments from the conference room.

She noted that “with the passage of the Cares Act, there’s more than a trillion dollars in debt … and there’s no sign of problems with that even in March or April,” when global governments first reacted to health crisis.

(Reporting by Ann Saphir and Howard Schneider and Dan Burns; Editing by Chizu Nomiyama)