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Concerns Arise Over U.S. Treasuries as Safe Haven Amid Pandemic

JACKSON HOLE, Wyoming (Reuters) – The traditional view of U.S. Treasuries as the safest of securities is facing scrutiny in light of new research. As the pandemic progressed, the performance of U.S. debt has begun to resemble that of other national and corporate bonds, prompting questions about its status as a global “safe haven.”

Presenting their findings at the Kansas City Fed’s annual conference, researchers from notable institutions such as New York University, the London Business School, and Stanford University examined shifts in investor behavior during the COVID-19 crisis. Their analysis casts doubt on the “exorbitant privilege” historically enjoyed by the U.S. government, which has been able to borrow extensively on the global stage even amidst expanding budget deficits.

This inquiry comes at a critical moment, as future U.S. deficits appear unavoidable regardless of the upcoming presidential election outcome.

Roberto Gomez-Cram from NYU, Howard Kung from the London Business School, and Hanno Lustig from Stanford challenge not only the notion that the Treasury market was dysfunctional during the pandemic—as suggested by the Federal Reserve’s aggressive bond-buying measures—but also argue that market behavior might have been a rational response to anticipated financial risks.

“In response to COVID, U.S. Treasury investors seem to have shifted to the risky debt model when pricing Treasurys,” the authors wrote, urging policymakers and central banks to consider these changing dynamics when evaluating bond market functionality.

The research focused on the dramatic shifts in Treasury yields during the 2020 pandemic shutdown, where, unusually, investors did not flock to U.S. Treasuries as they had in previous financial crises. Instead, Treasury securities faced markdowns akin to those experienced by other nations’ debts.

In response to rising yields, the Federal Reserve interpreted these market movements as indicative of dislocation, leading to significant bond purchases in efforts to stabilize what is typically the most liquid debt market globally, similar to actions taken during the Global Financial Crisis.

“In the risky debt regime, valuations will respond to government spending shocks, which may involve large yield changes in bond markets,” the paper observed, highlighting substantial market volatility coinciding with fiscal stimulus announcements.

The authors warned that large-scale asset purchases by central banks in reaction to government spending increases could have negative implications for public finance. They pointed out that while these purchases might temporarily support bond prices, they consequently diminish taxpayer value and could mislead governments about their actual fiscal capacities.

Responses and Critiques

The research garnered a mixed response, with several attendees, including officials from the U.S. Treasury, expressing the need for a more nuanced understanding of the pandemic’s uncertainties. U.S. Treasury Under Secretary for Domestic Finance, Nellie Liang, emphasized that the paper did not adequately consider the unprecedented conditions created by the pandemic. She referenced the successful financing of over a trillion dollars in fiscal responses without significant issues during the early pandemic months.

Liang noted that even amid heightened deficits, recent trends in U.S. bond yields showed a decline, further complicating the narrative proposed by the researchers.

The ongoing discussion underscores the evolving landscape of U.S. Treasuries and the broader implications for global financial stability as the world navigates through and beyond the pandemic.

Source
finance.yahoo.com