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With US public debt approaching wartime levels as a percentage of GDP, professional investors are understandably in a funk. Increasingly they question whether the US has the fiscal capacity to support the huge balance sheet liabilities it creates through its current account deficits.
Their worries are exacerbated — excuse the familiar litany — by Trump-induced geopolitical fragmentation, erratic policy shocks including a tariff policy designed to hurt America’s friends more than its foes, a sustained assault on Federal Reserve independence and neo-imperial threats to annex Greenland.
Indeed, Donald Trump has come close to exploding one of the great myths of the investment world, namely that sovereign bonds are safe, risk-free assets. His second coming has contributed significantly towards undermining the role of US Treasuries as the world’s ultimate capital market hedge. Long-standing doubts about the continuing pre-eminence of the dollar as a reserve currency have intensified.
Surveys of professional investors’ views on the US currency point to endemic weakness ahead despite the favourable differential between US and G10 interest rates. The prospect that an AI productivity miracle might provide a deus ex machina to relieve the US fiscal position seems tantalisingly speculative.
To be fair, worries about public debt are not confined to the US. Note, too, that from around the same time the yen, the quintessential global haven currency, began losing value.
This, according to Davide Oneglia of GlobalDataTS Lombard, is the opposite of what used to happen in “risk-off” periods when investors become more conservative. At the same time the historical correlation between the yen and other key asset prices has changed, weakening its risk asset hedging properties. Behind the shift are concerns about debt sustainability sparked by Prime Minister Sanae Takaichi’s election promises. Also contributing is the Bank of Japan’s normalisation of interest rates after the country’s protracted deflation.
In effect, says Oneglia, investors have reshuffled the hierarchy of safe haven assets, with the Swiss franc, Singaporean dollar, gold and German Bunds taking the lead in haven rankings.
Against this background the US Treasury market had to adjust last year to central banks’ quantitative tightening — the reversing of their asset purchasing programmes — and reserve managers’ waning appetite for American government debt.
Meantime, the “convenience yield” on US government IOUs — the premium investors place on holding such securities for their safety and liquidity — has declined, thereby eroding the subsidy enjoyed by US taxpayers from the issue of supposedly safe assets. And the hedging benefits of government debt have diminished as stocks and bonds have become more closely correlated.
While the weakness of the dollar owes something to the increasingly negative foreign asset position of the US, it is not driven exclusively by foreign investors. According to State Street, US investors were behind the dramatic sell-off in the dollar in the first half of last year, more than halving how much they hedge their foreign currency exposures — in other words, selling dollars — from about 25 per cent at the start of 2025 to a low of a little above 12 per cent.
There is a logic to that diversification, especially in relation to Europe. In a note that remains relevant ttoday,Marc Seidner and Pramol Dhawan of fund manager Pimco pointed out in 2024 that it makes sense to be structurally short of the US public sector versus the private sector while the opposite holds true in Europe where growth momentum remains stalled and fiscal responses remain constrained.
In essence the US boasts a stronger income statement while the EU largely has a stronger balance sheet. There is a trade-off: the US can grow but is in uncharted territory; Europe is struggling to grow but has been able to navigate turbulence such as Brexit and the Greek debt crisis. It is thus logical to seek equity exposure in the US and debt exposure in Europe.
Certainly foreign investors have increased their share of US equities while lowering their share of US Treasuries which raises the paradoxical thought that US equities may be becoming the global reserve asset.
The larger paradox is simply that sovereign bonds could ever have been referred to as safe assets. Yes, they are less volatile than equities but they are subject to destruction by inflation. Crucially, Elroy Dimson, Paul Marsh and Mike Staunton have shown in the UBS Global Investment Returns Year Book that bond market drawdowns — peak to trough falls — have historically been larger and/or longer than for equities. Note, in passing, that the US bond market drawdown from July 2020 inflicted a real loss on investors of 51 per cent.
Of course US Treasuries will not cease to be a powerful magnet for global capital. De-dollarisation will be a very protracted business. The lesson is simply that in capital markets the concept of safety is strictly relative.
john.plender@ft.com
