PGIM Fixed Income: US Treasuries remain a gold standard

August 3, 2023

This news doesn’t change much — US Treasuries remain in terms of liquidity, size, and security a gold standard among DM government bond markets — and this is likely to remain the case for years, if not decades.  So in some sense, these are 'vanity ratings' at least for the time being.

It does, however, cause people to stop and ask questions, about the US’ poor debt dynamics.  It is true as Fitch highlights that there has been an erosion of governance in the US. The fiscal framework of the 1990s is gone, as is the budget surplus, replaced by alarmingly large deficits, along with more frequent threats of government closure, and default.

Meanwhile, the fundamental problem of spending exceeding revenues remains entirely unaddressed, allowing the US’ debt to GDP ratio to soar from 40% to over 100% since 2000 — a level that just a decade ago during the Eurozone crisis would have been considered dangerously high — in the “danger zone” for sovereign credits.

One saving grace on a relative basis is that many DM countries have experienced a similar mushrooming of government debt in recent years.  Furthermore, carrying out QE during times of fiscal stimulus — effectively monetary financing — once taboo, is now commonplace.

In terms of Treasury yields, the additional supply of Treasuries hitting the market as the deficit rises has put, and will continue to put, inexorable upward pressure on Treasury yields relative to other fixed income instruments, such as SOFR swaps.

While a major swing in the near term is not anticipated, over time this relative supply / demand dynamic has taken long term Treasury yields from less than swap yields by 30+bp in the 1990s to now typically 50+bp above swap rates.  So yes, there is an impact of the US’ rising debt burden, but at least to date the rate of change has been incredibly slow.

Therefore, as for the here and now, economic fundamentals of growth and inflation, central bank policy, remain the primary drivers of yield levels, which are broadly in the realm of fair value — we are in the end game of a rate hike cycle, and therefore near peak yields.  Downgrade or not, US fixed income is poised for healthy return in the years ahead.