Despite recent volatility and concerns over the US fiscal position, US Treasuries remain a reliable safe-haven asset, according to Rick Patel, portfolio manager at Fidelity International.
Market participants have been unsettled by geopolitical tensions and trade-related news, alongside the recent US credit downgrade by Moody’s and concerns about the size of the US fiscal deficit. However, Patel maintains that these fears are overstated.
The US had been under ‘negative watch’ from Moody’s for 18 months before the downgrade, meaning it was not unexpected. Importantly, Moody’s continues to highlight the “exceptional credit strengths” in US, including “the size, resilience and dynamism of its economy and the role of the US dollar as the global reserve currency.”
Patel adds: “The size, liquidity and strength of the US market is unparalleled and irreplaceable and we expect US Treasuries and credit to remain a key allocation for investors globally.”
While the projected fiscal deficit of approximately 7% over the next few years is concerning, Patel says it is crucial to break down this figure. About half of the deficit can be attributed to interest payments on Treasury debt and the other half to fiscal spending. As the US moves closer to possible Federal Reserve rate cuts, interest expenses should decrease, reducing the size of the deficit. Patel notes, “This would limit concerns from bond markets about the debt to GDP ratio.” He does, however, caution that if the US economy weakens, the government’s ability to offer fiscal support will be more limited than in past crises.
The need for increased bond issuance has also raised questions about continued overseas demand. Patel observes, “The trend of Japanese and Chinese institutional investors slightly reducing their allocation to the US has already been taking place for some years now, with a limited impact on overall demand.”
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Patel’s confidence in the resilience of demand for US Treasuries is grounded in the composition of domestic wealth. US households, compared to those in other countries, have a much higher allocation to equities. This provides scope for a shift towards fixed income, particularly if attractive Treasury yields persist. Patel explains, “A 1% increase in US domestic allocations to fixed income would likely fund the increased US Treasury issuance for the next two to three years.”
Such an asset allocation shift could occur organically, as pensions, insurers and multi-manager accounts are incentivised by higher yields to increase their treasury holdings, reducing the need for active rebalancing by individual investors. Patel also suggests that “there may be some form of tax incentive from the US government” to support this transition.
Despite ongoing uncertainties, Patel is convinced that US Treasuries are well placed should the US economy weaken and trigger a flight to quality. He states, “The fact is there are few viable alternatives to treasuries, and we expect a very limited change in demand in the long term.”
