Macro & Market Views
Reflections: Welcome Letter from Mehdi Mahmud
Reflections: Welcome Letter from Mehdi Mahmud
Are we living through a generational re-pricing of risk in US Treasuries?
President and Chief Executive Officer
Denominated in the global reserve currency and backed by the full faith and credit of the world’s premier economic and military power, Treasuries have long been considered a risk-free asset; boring, perhaps, but unlikely to lose money. A potential “safe haven” during times of trouble
And this conviction has largely held true since the early 1980s, when US interest rates entered a secular decline and sparked a bull run in bonds that lasted longer than most of us have been involved in the financial markets. Yields did not move monotonically lower over this period, but fluctuations throughout were marked by lower peaks and deeper valleys until the 10-year rate in 2020, amid the massive policy response to the Covid-19 outbreak, fell below 1% for the first time.1
The subsequent inflation shock forced the Federal Reserve in March 2022 to launch what turned out to be the most aggressive rate-hike cycle in its history, bringing the long bull market abruptly to heel.2
The sharp selloff across the yield curve served as a reminder that while Treasuries remain free from credit risk—in theory, at least—they are subject to the same duration risk as any other fixed-rate asset. It also sent the message that the resulting price movements can have real-world impacts, as several midsized US regional banks failed in March 2023 after being forced to liquidate their Treasury holdings at massive losses to meet depositor withdrawals.
For much of the past two years, Treasuries have traded largely in tandem with expectations of near-term monetary policy, which resulted in significant volatility as markets tried—and mostly failed—to get an accurate read on the path of the federal funds rate. Interestingly, longer-term Treasury yields have been biased higher since rate cuts commenced in September 2024; here in mid-January, the yield on 10-year Treasuries is approaching 5%, a level not seen since the early days of the global financial crisis.3 Though higher Treasury yields at this stage could reflect optimism about future economic growth, they also could be sniffing out something more troubling.
US fiscal policy has been on an unsustainable trajectory since the global financial crisis, as the government provided extensive support in response to two large-scale economic dislocations. This federal largesse was supported by very low interest rates that kept interest expenses manageable and by long-lived, large-scale quantitative easing programs that provided ample demand for government debt. While the rollback of crisis-era monetary accommodations altered the calculus of government borrowing, there are few indications that fiscal policy will be meaningfully adjusted to reflect the new math.
Of course, the US is not the only country on an unviable fiscal course. The International Monetary Fund projects public debt worldwide to approach 100% of gross domestic product by 2030 and notes significant upside risk to this baseline forecast.4 It’s possible that the results of 2024’s elections, which were not kind to the political status quo, reflected the electorate’s sensitivity to the financial vulnerability such debt represents, if only subconsciously. With more than 70 countries holding national elections, incumbent parties across the political spectrum lost hold of power or saw it weakened, with economic dissatisfaction—and the high cost of living, more specifically—helping fuel the anti-incumbency bias.5 “Voting out the bums” may provide a hit of electoral schadenfreude, but it’s unclear how some of the measures upon which 2024’s victors campaigned will provide the relief voters seek.
Also unclear is how current sovereign debt trends may impact investor perception of risk premia across asset classes. The term premium6 on 10-year Treasuries—which has been negative more often than not since 2016—turned positive in October and has been biased higher since.7 This move may reflect the start of a return to more normal levels of duration risk assessment, or it could be a sign that markets have begun to recalibrate their view of future US creditworthiness amid a background of high and rising debt. Waning confidence in the stability of Treasuries could threaten the US dollar’s role as the preeminent global reserve currency at the same time other currencies and gold have eaten into the dollar’s share of central bank reserves, emerging markets are calling for the “de-dollarization” of trade, and crypto continues to make slow inroads into commerce.8 It could also force a future reckoning of which assets represent perceived “safe havens.”
It seems prudent to consider the impact a meaningful re-rating of Treasury risk could have on the institutions that hold these securities and asset prices more broadly. Highly concentrated, richly valued markets such as US equities may be particularly vulnerable to a rate shock. Lofty returns for the S&P 500 Index in recent years have been driven by the outsized performance of a small handful of very large tech-oriented stocks, a dynamic that camouflaged a market far more nuanced than it appears on the surface while also challenging investors’ efforts to achieve portfolio diversification through beta exposure.9
Whether or not Treasuries are on the verge of a generational transformation, I’m confident First Eagle will be up for the challenge. Drawing on a heritage dating back to 1864, the firm has served as a prudent steward of client capital across market cycles, varying macroeconomic conditions and numerous disruptive events. In more recent years, we have deliberately built out an investment platform—introducing new teams, new strategies and new vehicles—equipped to provide a range of global investors with modern solutions to modern challenges.
Sincerely,
Mehdi Mahmud
President and Chief Executive Officer,
First Eagle Investments
December 2023