In all tradable markets and currencies, US Treasuries—government bonds—have significant influence. in finance, Any measure of risk is relative, that is, if a home is insured, the maximum liability is fixed in some form of money.
Similarly, if a loan is requested from a bank, the creditor has to calculate the probability that the money will not be repaid and the risk that the amount will be devalued by inflation.
In the worst case, imagine what would happen to the costs associated with issuing debt if the US government temporarily suspended payments to certain regions or countries. Currently, there is more than USD 7.6 trillion in bonds held by foreign entities and multiple banks and governments depend on this cash flow.
The potential cascading effect of countries and financial institutions would immediately affect their ability to settle imports and exports, leading to further carnage in lending markets as all participants rush to reduce their exposure to risk.
There is more than $24 trillion in US Treasuries in the hands of the general public, so participants generally assume that the least risk out there is a government-backed debt security.
The Treasury yield is nominal, so inflation must be taken into account
The yield reported in the media is not the yield professional investors trade, because each bond has its own price. Nevertheless, Based on contract expiration, traders can calculate the equivalent annualized yield, making it easier for the general public to understand the benefit of owning bonds. For example, the 90-year 10-year US Treasury purchase entices the owner with a 4% equivalent yield through contract expiration.
If the investor thinks that inflation will not be contained anytime soon, the tendency is for those participants to demand a higher yield when trading the 10-year bond.. On the other hand, if other governments risk becoming insolvent or hyperinflating their currencies, those investors will most likely seek refuge in US Treasuries.
A delicate balance allows US government bonds to trade below competitive assets and even below expected inflation. Although it was inconceivable a few years ago, Negative yields became quite common after central banks cut interest rates to zero to boost their economies in 2020 and 2021.
Investors are paying for the privilege of having the safety of government-backed bonds instead of facing the risk of bank deposits. As crazy as it sounds, there are still more than $2.5 trillion worth of negative-yielding bonds out there, which don’t take into account the impact of inflation.
Normal bonds are pricing in higher inflation
To understand how disconnected US government debt is from reality, keep in mind that the 3-year bond yield stands at 4.38%. In the meantime, consumer inflation stands at 8.3%, so investors either believe the Fed will successfully smooth the metric, or they are willing to lose purchasing power for the world’s lowest-risk asset.
In modern history, the United States has never defaulted on its debt. In simple terms, the debt ceiling is a self-imposed limit. Thus, Congress decides how much debt the federal government can issue.
For comparison, an HSBC Holdings bond due August 2025 is trading at a yield of 5.90%. Basically, the US Treasury yield should not be interpreted as a reliable indicator of inflation expectations. Also, the fact that it has reached the highest level since 2008 is of less importance, as the data shows that investors are willing to sacrifice profits for the safety of owning the lower-risk asset.
Consequently, US Treasury yields are a great metric against other countries and corporate debt, but not in absolute terms. Those government bonds will reflect inflation expectations, but could also be severely constrained if the overall riskiness of other issuers rises.
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