Government bonds, also known as sovereign debt or treasury securities, are often referred to as "riskless" or "risk-free" assets because the government backing those debts can always collect taxes or print new money to service them. With the world experiencing a period of prolonged low interest rates, and with the reality of negative interest rates sweeping the globe, many investors, as well as the Wall Street Journal are now asking if treasuries have become a risky asset. (See also: How to Protect Your Portfolio From Brexit Fallout.)
Treasuries a Home for Capital Inflows
With global macro uncertainty still high due to destabilizing events such as England's recent vote to leave the European Union, investors are scrambling to find safe havens where they can park their cash. This leads them to high-quality government debt issued by the world's largest and most stable economies. Europe, Switzerland and Japan, however, all have negative interest rate policies (NIRP), deterring investors from placing too much money in securities that will force them to pay a penalty. This makes the United States especially attractive. (See also: Is Gold a Safe Haven?)
Professional money managers agreed at a recent meeting that U.S. Treasuries appear to be overvalued at current low interest rates. As investors buy bonds and bid their prices higher, it pushes interest rates downward. Many investors are concerned that they are being compensated too little at these low rates to justify buying more sovereign debt.
How Safe Is This Haven?
A major concern is that these bonds are not being valued using fundamentals, but are instead being used as a safe haven to avoid risk, exposing weakness in the economy and possibly predicting a downturn in the short- to medium-term. Meanwhile, the equity risk premium priced into equities remains elevated near its highest level in 70 years, implying that shareholders are being well-paid for the risk that prices will tumble, according to a Deutsche Bank analysis.These low implied interest rates also may be at odds with inflation data, which shows that prices paid by both consumers and producers in America have been rising. As such, we may see a correction in U.S. government bonds, pushing yields up back above 2% for 10-year maturities. This puts treasuries in the category of risky, volatile assets.
U.S. stocks set their first record in more than a year this week, but for much of this year the Dow Jones Industrial Average and S&P 500 haven’t been star performers. Instead, large gains in supposedly low-risk, long-term securities have taken government-bond prices sharply higher, raising concerns that they are due for a fall that could quickly push yields back up toward 2% in a replay of the “taper tantrum” of 2013. Treasury yields jumped in the summer of 2013, as investors fretted that the Federal Reserve would soon end its bond-purchase program.
Source: Wall Street Journal
The Bottom Line
As investors around the world flock into U.S. Treasury securities, they are driving up the prices of these bonds – thus depressing their yields – to levels that seem to be out of line with fundamentals. Seen as a safe haven asset, investors may no longer regard them as "risk-free" until their prices come back in to line with reality.