In all tradable markets and currencies, the US Treasury – government bonds – has a significant impact. In finance, any measure of risk is relative, meaning that if one insures a home, the maximum liability is set in some form of money.
Likewise, if a loan is obtained from a bank, the creditor must calculate the odds of not returning the money and the risk of depreciation of the amount due to inflation.
In a worst-case scenario, let’s imagine what would happen to the costs associated with issuing debt if the US government temporarily suspended payments to certain regions or countries. There are currently more than $7.6 trillion in bonds held by foreign entities, and many banks and governments rely on this cash flow.
The potential cascading effect from countries and financial institutions will immediately affect their ability to settle imports and exports, leading to more carnage in the lending markets because each participant will rush to reduce exposure.
There are more than $24 trillion in US Treasuries held by the general public, so participants generally assume that the lowest risk that exists is a government-backed debt security.
Treasury yield is nominal, so consider inflation
The yield that is widely covered by the media is not what professional investors are trading, because each bond has its own price. However, based on the contract’s maturity date, traders can calculate the equivalent annual yield, making it easier for the general public to understand the benefit of owning the bond. For example, buying a 10-year US Treasury at 90 tempts the owner with a 4% return until the contract matures.
US government bond yield for 10 years. Source: TradingView
If an investor believes that inflation won’t be contained anytime soon, the trend is for these participants to demand a higher yield when trading 10-year bonds. On the other hand, if other governments are in danger of bankruptcy or excessively inflating their currencies, these investors are likely to seek refuge in US Treasuries.
A delicate balance allows US government bonds to trade less than competing assets and even fall below expected inflation. Although unimaginable a few years ago, negative yields became very common after central banks cut interest rates to zero to boost their economies in 2020 and 2021.
Investors pay for the privilege of obtaining the security of government-backed bonds rather than taking on the risk of bank deposits. As crazy as it may sound, over $2.5 trillion in negative-yielding bonds still exists, which doesn’t take into account the impact of inflation.
Ordinary bonds have higher inflation pricing
To understand how disconnected US government bonds are from reality, one needs to realize that the three-year bond yield is 4.38%. Meanwhile, consumer inflation is at 8.3%, so either investors believe the Fed will succeed in easing the scale or they are willing to lose purchasing power against the world’s less risky assets.
In recent 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, the HSBC Holdings bond due in August 2025 is trading at a yield of 5.90%. Essentially, one should not interpret US Treasury yields as a reliable indicator of inflation expectations. Moreover, the fact that it reached its highest level since 2008 bears less significance because the data shows that investors are willing to sacrifice profits in order to secure ownership of the less risky assets.
Thus, US Treasury yields are a great tool for benchmarking against corporate and other country debt, but not in absolute terms. These government bonds will reflect inflation expectations but can also be severely restricted if the overall risk to other issuers increases.
