A risky safe asset: The vulnerabilities of US Treasuries

Quick read:

• The US Treasury sell-off in the aftermath of the “Liberation Day” tariff announcement is a stark reminder of the investment risks embedded in government bonds – particularly with the ongoing deterioration of US deficit fundamentals and low yields on long-dated debt relative to cash.
• The rising supply of US government bonds will increasingly need to be financed by price-sensitive domestic buyers since global investors currently lack a yield incentive to increase allocations to increasingly risky US debt.
• Across our tactical liquid alternative portfolios, we remain short 30-year US Treasury bonds outright and short US fixed income versus more austere and attractively priced markets like the UK, Eurozone, and Sweden.

April’s sharp sell-off of long-dated US Treasuries highlights risks in the world’s largest bond market, particularly in the current regime of high deficits and elevated inflation. The imposition of tariffs on trading partners is likely to increase geopolitical fragmentation, prices, and deficits while decreasing the incentive for foreigners to finance additional US government borrowing. Suppressed long-end yields relative to cash rates means that domestic bond investors currently don’t receive much risk-adjusted yield compensation for bearing elevated issuance and inflation risks. We also note that the rising correlation between the US$ and US Treasuries is consistent with a rising US country risk premium that could lower the incentive for foreigners to add exposure to US government debt.

Expensive and risky for foreigners

Tariffs are inflationary, especially if they coincide with a depreciating currency. Since the US runs a current account deficit and its borrowing is partially financed by foreigners, this rise in inflation risk reduces the appeal of Treasuries as a long-term store of value. A decade of US central bank purchases, dovish central bank guidance, and a sell-off in the US$ have also conspired to make long-dated US Treasuries a relatively expensive asset for foreign buyers. At the right price or yield, investors might feel sufficiently well-compensated to finance the rising US government policy risks, particularly in the world’s largest and most innovative economy, but that level of yields is likely higher on both an absolute and relative basis.

Currency-hedged US Treasuries yield less than European or Japanese local equivalents

^{Source: BlackRock with data from Bloomberg, April 2025. Chart compares the yields on 10-year European and Japanese Government Bonds to the yield of 10-year US Treasuries FX-hedged back to euro and Japanese Yen, respectively. A more positive (negative) value is indicative of an incentive (disincentive) for foreigners to invest in US Treasuries on a hedged basis.}

The “expensiveness” of Treasuries manifests itself most at the long-end of the yield curve where yields are not much higher than prevailing US cash rates. The visual above shows the relative (un)attractiveness of US 10-year bond yields for foreign investors by comparing them on an FX-hedged basis to local government bonds. US Treasuries currently offer a lower hedged yield compared to domestic 10-year government bonds in Europe and Japan. This means there is currently a price-/yield-incentive for foreigners to reduce their (already large) US Treasury holdings. US yields will have to rise relative to foreign markets before price-sensitive foreigners have a yields-based incentive to finance additional US deficits.

Americans need a steeper yield curve to compensate for risks

US households are also price-sensitive bond buyers that have many fixed income alternatives. The relative attractiveness of buying long-dated Treasuries has declined for Americans in recent years as the yield curve has flattened and bond volatility has risen. The visual below shows the challenging risk-adjusted yield backdrop for US Treasuries relative to the past. The additional yield pick-up from buying a 10-year bonds versus 2-year bonds has collapsed compared to previous decades while long-dated bond volatility has simultaneously normalized. Without a larger “term premium” to compensate investors for bearing longer-term economic risks, it will be challenging to get Americans to increase the maturity profile of their fixed income holdings.¹

Long-end US Treasuries offer a meager yield uplift and rising portfolio risk

^{Source: BlackRock with data from Bloomberg, April 2025. Bars show average based on monthly data over each 10-year period, from January 1 of the first year to December 31 of the final year of the decade. “2020s” is from January 1, 2020 through March 31, 2025. Volatility is measured by standard deviation.}

There are signs of relatively low investor appetite to increase government bond holdings across other market participants as well:

• Weaker Auctions: Two indicators that point to diminishing demand for new issuance are the spread at each auction between the median and lowest accepted price has been rising and the bid-to-cover ratios have been declining since 2020 compared to the previous decades.²
• Tapered QT: The Federal Reserve opted to further scale down its already benign quantitative tightening program recently despite ample liquidity conditions. This indicates that the central bank feels a need to retain a much heftier footprint in the long-end of the US Treasury market compared to the pre-pandemic era.
• Basis Trades: Since 2019 there has been a large price incentive for hedge funds to add to holdings of cash Treasury bonds (and simultaneously to short Treasury futures). That cash-futures basis has gone away in early 2025, which lowers the appeal for fixed income hedged funds to buy cash Treasury bonds.³

Twin deficits have consequences

Creditworthiness is rightly not a part of the typical discussions around the price fluctuations of US Treasuries. The United States borrows in its own currency and has numerous economic advantages that confer a special global status to US government debt.⁴ However, US Treasury prices do respond to shifts in America’s macroeconomic fundamentals, particularly when US deficit, trade, and inflation dynamics diverge from other large, developed economies like the Eurozone and Japan. Global fixed income capital is responsive to shifts in sovereign credit fundamentals like the expected trajectory of budget deficits – which impact future bond supply – along with the size of the current account deficit – which is a measure of the degree to which foreigners must fund deficits. The ongoing deterioration of both of these metrics in the US create a challenging fundamental backdrop for Treasuries.

The worrisome trajectory of US deficits is a major source of economic uncertainty

^{Source: BlackRock with data from the Congressional Budget Office (CBO) and U.S. Congress, April 2025.}

The visual above plots the federal primary balance and projections of future borrowing needs excluding interest costs. The proposed US budget bills being considered in the reconciliation process have a wide range of possible deficit sizes, but appear likely to result in a $1+ trillion primary deficit that will generate a worrisome rise in the near-dated supply of US government debt.⁵ This fiscal trajectory would make for a challenging supply-demand backdrop for US Treasuries even in the absence of the recent escalation of tariff policy.

What does this mean for portfolios?

In our tactical liquid alternative portfolios, we seek to deliver returns that are lowly correlated with stock and bond markets. We use macro data related to growth, inflation, policy and market pricing to seek out long and short investment opportunities across countries and asset classes.

We interpret recent policy developments to be negative for US Treasuries and have added to directional and cross-country short positions in portfolios. The relative unattractiveness of long-dated US Treasuries – both on a risk-adjusted basis for Americans and relative to higher yielding local alternatives for foreigners – exacerbate the risks that foreign purchasers might see in either tariff policy uncertainty or the deficit implications of the “Big Beautiful Bill.” Long-dated Treasury bonds are likely to continue to face material investment risks in the current environment.