From unicorns to ponies: US Treasuries are losing their luster From unicorns to ponies: US Treasuries are losing their luster From unicorns to ponies: US Treasuries are losing their luster

From unicorns to ponies: US Treasuries are losing their luster

Bonds
Althea Spinozzi

Head of Fixed Income Strategy

Summary:  Opposite to what happened in 2011, Fitch's US rating downgrade might prove to be bearish for US Treasuries for a straightforward reason: why would investors buy ten-year US Treasuries (AA+) at 4% when USD hedged ten-year Bunds (AAA) pay 4.25%? Not only that, but the "soft-landing" scenario and larger US treasury auctions spell for higher yields. Ten-year yields are likely to head towards 4.3%, while two-year yields are likely to test resistance again at 5.04%. Yet, the rise in yields will be stopped abruptly when something breaks, which is more likely to happen as yields continue to soar.


Fitch cut the US rating downgrade because of an “expected fiscal deterioration over the next three years, a high and growing general government debt burden, and the erosion of governance relative to 'AA' and 'AAA-rated peers over the last two decades that has manifested in repeated debt limit standoffs and last-minute resolutions." Such a decision would put pressure on any country's government bonds. However, it did not trouble US Treasuries; why?

The answer to that question relates to the fact that US Treasuries are notoriously regarded to be a safe haven. A deterioration of the US economy implies higher risks in the corporate space. Therefore, investors would sell risky assets and flee to safety. Guess where they would find safety? In US Treasuries!

Although Fitch’s downgrade differs in many ways from the 2011 S&P downgrade, it makes sense to revisit this event to understand what has happened in the past.

On August the 5th, 2011, a few days after Congress agreed to increase the US debt ceiling solving a debacle going on for months, S&P downgraded the US government rating from AAA to AA+. US Treasuries rallied across maturities, with 10-year dropping by 38bps by the end of August.

Back then, market participants understood the considerable problem the market would run into if another rating agency were to cut the US rating, pushing US debt into AA+ territory rather than AAA. That’s why since then, contracts such as repurchase agreements, loans, and derivatives have been written to include “debt backed by the US government.” This is why yesterday’s Fitch credit downgrade will not force the unwinding of such contracts, removing a lot of pressure that otherwise might have been applied to US Treasuries.

The most significant risk the market faces in the upcoming weeks is the reconsideration of credit risk in financial markets. If the US economy is deteriorating, that's bad news for the US corporate space. Therefore, some investors might see scope to sell risky assets to flee to safety, which they can find where? In US Treasuries!

Source: Bloomberg.

This time around, a rating downgrade might spell troubles for US Treasuries

However, This time around, the US Treasuries rally might not last. Indeed, several factors contribute to a bearish US Treasury outlook in the upcoming weeks:

(1) The German Bund offers better risk and reward. While US Treasuries were mostly flat following the Fitch rating downgrade, Bunds rallied. The reason for such outperformance is simple: once hedged against the USD, German Bunds (AAA) pay a yield of 4.25%, 25bps points higher than their US peers (AA+). Therefore, why would risk-sensitive investors stay in US Treasuries when they can get a better payoff in Bunds? That could add to the US Treasury's weakness in the next few weeks.

Source: Bloomberg.

(2) The “soft landing” scenario translates into higher rates, which will trouble the US economy. The soft-landing fairy tale has short legs for one simple reason: if the economy remains solid, but core inflation is expected to end the year at 4.2%, the Federal Reserve might need to continue to hike interest rates. The hiking pace might be slower, but the peak rate might be much higher than the market forecasts. Long-term yields might continue to soar, putting more pressure on the economy. In other words, US Treasury yields will continue to soar until something breaks. At that point, the Federal Reserve will not be able to hold rates at high levels for long, and a bull bond market might form.

(3) Higher bond issuance will also translate into higher yields. The Treasury has announced today that it will lift refunding auctions by $7 billion to $103 billion, boosting auction sizes for all nominal bonds. That builds upward pressure for yields across maturities, painting a bearish picture for US Treasuries.

US Treasuries yields: what's next?

Ten-year yields are testing resistance at 4.08% and are likely to break above it to continue to soar toward 4.31%

Source: Bloomberg.

Quarterly Outlook 2024 Q3

Sandcastle economics

01 / 05

  • Macro: Sandcastle economics

    Invest wisely in Q3 2024: Discover SaxoStrats' insights on navigating a stable yet fragile global economy.

    Read article
  • Bonds: What to do until inflation stabilises

    Discover strategies for managing bonds as US and European yields remain rangebound due to uncertain inflation and evolving monetary policies.

    Read article
  • Equities: Are we blowing bubbles again

    Explore key trends and opportunities in European equities and electrification theme as market dynamics echo 2021's rally.

    Read article
  • FX: Risk-on currencies to surge against havens

    Explore the outlook for USD, AUD, NZD, and EM carry trades as risk-on currencies are set to outperform in Q3 2024.

    Read article
  • Commodities: Energy and grains in focus as metals pause

    Energy and grains to shine as metals pause. Discover key trends and market drivers for commodities in Q3 2024.

    Read article

Disclaimer

The Saxo Bank Group entities each provide execution-only service and access to Analysis permitting a person to view and/or use content available on or via the website. This content is not intended to and does not change or expand on the execution-only service. Such access and use are at all times subject to (i) The Terms of Use; (ii) Full Disclaimer; (iii) The Risk Warning; (iv) the Rules of Engagement and (v) Notices applying to Saxo News & Research and/or its content in addition (where relevant) to the terms governing the use of hyperlinks on the website of a member of the Saxo Bank Group by which access to Saxo News & Research is gained. Such content is therefore provided as no more than information. In particular no advice is intended to be provided or to be relied on as provided nor endorsed by any Saxo Bank Group entity; nor is it to be construed as solicitation or an incentive provided to subscribe for or sell or purchase any financial instrument. All trading or investments you make must be pursuant to your own unprompted and informed self-directed decision. As such no Saxo Bank Group entity will have or be liable for any losses that you may sustain as a result of any investment decision made in reliance on information which is available on Saxo News & Research or as a result of the use of the Saxo News & Research. Orders given and trades effected are deemed intended to be given or effected for the account of the customer with the Saxo Bank Group entity operating in the jurisdiction in which the customer resides and/or with whom the customer opened and maintains his/her trading account. Saxo News & Research does not contain (and should not be construed as containing) financial, investment, tax or trading advice or advice of any sort offered, recommended or endorsed by Saxo Bank Group and should not be construed as a record of our trading prices, or as an offer, incentive or solicitation for the subscription, sale or purchase in any financial instrument. To the extent that any content is construed as investment research, you must note and accept that the content was not intended to and has not been prepared in accordance with legal requirements designed to promote the independence of investment research and as such, would be considered as a marketing communication under relevant laws.

Please read our disclaimers:
Notification on Non-Independent Investment Research (https://www.home.saxo/legal/niird/notification)
Full disclaimer (https://www.home.saxo/legal/disclaimer/saxo-disclaimer)
Full disclaimer (https://www.home.saxo/legal/saxoselect-disclaimer/disclaimer)

Saxo Bank (Schweiz) AG
The Circle 38
CH-8058
Zürich-Flughafen
Switzerland

Contact Saxo

Select region

Switzerland
Switzerland

All trading carries risk. Losses can exceed deposits on margin products. You should consider whether you understand how our products work and whether you can afford to take the high risk of losing your money. To help you understand the risks involved we have put together a general Risk Warning series of Key Information Documents (KIDs) highlighting the risks and rewards related to each product. The KIDs can be accessed within the trading platform. Please note that the full prospectus can be obtained free of charge from Saxo Bank (Switzerland) Ltd. or the issuer.

This website can be accessed worldwide however the information on the website is related to Saxo Bank (Switzerland) Ltd. All clients will directly engage with Saxo Bank (Switzerland) Ltd. and all client agreements will be entered into with Saxo Bank (Switzerland) Ltd. and thus governed by Swiss Law. 

The content of this website represents marketing material and has not been notified or submitted to any supervisory authority.

If you contact Saxo Bank (Switzerland) Ltd. or visit this website, you acknowledge and agree that any data that you transmit to Saxo Bank (Switzerland) Ltd., either through this website, by telephone or by any other means of communication (e.g. e-mail), may be collected or recorded and transferred to other Saxo Bank Group companies or third parties in Switzerland or abroad and may be stored or otherwise processed by them or Saxo Bank (Switzerland) Ltd. You release Saxo Bank (Switzerland) Ltd. from its obligations under Swiss banking and securities dealer secrecies and, to the extent permitted by law, data protection laws as well as other laws and obligations to protect privacy. Saxo Bank (Switzerland) Ltd. has implemented appropriate technical and organizational measures to protect data from unauthorized processing and disclosure and applies appropriate safeguards to guarantee adequate protection of such data.

Apple, iPad and iPhone are trademarks of Apple Inc., registered in the U.S. and other countries. App Store is a service mark of Apple Inc.