US Treasuries are not “safe”

The only real question at this point for anyone with eyes in front of their head is: Why?

US Treasuries haven’t been bad for a year or two.

Few will tell you this, but in reality, they have been stinking for almost two generations. Even after the epic collapse of the last few years, they still don’t look great.

This is especially concerning for retirees, because in most cases their entire portfolio is based in bonds. Treasury bills, municipal bonds, investment grade corporate bonds and high yield bonds. They’re all pretty much in the same bag.

Consider some grim numbers: An investment in 10-year U.S. Treasuries BX: TMUBMUSD10Y has lost a third of its value, in real, inflation-adjusted terms, in just over three years. Investments in long-term Treasury bonds have lost about half their value. They fell as much as U.S. stocks did during the global financial crisis.

10-year Treasury bonds have been a worse investment than gold bullion this year, last year, the year before that, and through 2018.

And this is not just a short-term phenomenon. Ten-year Treasuries have failed to keep up with inflation since the spring of 2008, before the collapse of Lehman Brothers. In fact, they haven’t made you any money, after inflation, since 2003: not one lost decade, but two, consecutively.

This is before taxes on interest payments.

Ten-year Treasuries have proven to be a worse investment than gold bullion since the first Gulf War in 1990. Seriously. According to New York University data, if you had invested $10,000 in 10-year Treasury bonds in early 1990, you would have just over $20,000 today (measured in constant dollars , i.e. after adjusting for inflation).

The figure for gold bars over the same period: $23,000. That’s about 15% more.

Furthermore, most of those who tell you that US Treasury bonds are “safe” are also saying that gold is a speculative and risky asset. Many of them also told you to expect 5% per year from Treasuries, “consistent with historical averages,” even when those bonds had yields of only 2% or less.

Typically, after such a long and dismal period of underperformance, you would think that an investment probably looks cheap and is a decent buy. But is this the case?

In the short term, most likely. Treasuries could prove to be a great trade over the next six months or year, especially if the U.S. economy enters a recession.

But as a long-term investment?

Even after all this disastrous performance, buying a 10-year Treasury today is like explicitly betting that inflation will collapse overnight, from time to time, and stay low. Based on so-called “breakeven points,” which compare the yields of regular Treasuries and inflation-protected Treasuries, anyone who buys regular 10-year Treasuries assumes that inflation will be on average 2.3% over the next decade.

Good luck with that.

Anyone betting on this should turn their attention away from the Federal Reserve, which has monopolized the bond market’s attention for years, and toward the unfunny “duck soup” reboot we call the modern American political system.

The Republican presidential candidates who bothered to participate in the last debate all promised to create miraculous economic growth and painless, invisible cost savings to fix skyrocketing deficits without raising taxes or making anyone suffer in the middle class.

Meanwhile, even though Social Security already has a funding hole in its books equal to the size of the U.S. gross domestic product, Democrats have lined up to propose ways to further increase benefits.

Chicago-based fund manager Josh Strauss says it well. “On one side you have the Democrats, who want to tax and spend, and on the other side, you have the Republicans, who want to tax and spend. The American citizen has become totally accustomed to a government that spends a lot of money and thinks it could do it with less taxes.”

In the UK there is a term for this: “cakeism”, which refers to a political agenda based on having the cake and eating it. Lower taxes? Higher expenses? Why choose one when you can have both! Britain is no better managed than the US, but at least they have the good sense to criticize their political class. Here in the United States, someone can present an entire political agenda based on cakeism, and the audience just applauds.

The results are evident for all to see. The federal government currently runs a larger budget deficit, relative to the economy, than Franklin Roosevelt’s at the depths of the Great Depression: 5.9% of GDP today, compared to 5.8% in 1934.

This at a time when unemployment is at an all-time low, businesses can’t find staff, and the Fed is desperately trying to slow growth to control inflation. And yet in this environment we apparently need massive budget deficits. More cake all around.

In its most recent report, the Congressional Budget Office predicted that these deficits would decline to… er… 5 percent of GDP by 2027, then increase again, each year, to 6.4 percent by 2033, and to more than 8% by 2043, “reaching 10.0 percent of GDP in 2053.”

This is based on the assumption that the 2017 Trump tax cuts will all expire in 2026. How likely is that to be the case?

Federal budgets are not a sea of ​​red ink but an ocean that stretches as far as the eye can see. The official national debt already represents 98% of annual GDP, according to the most recent figures from the CBO. By 2029, it is expected to reach a new record of 107%, surpassing the total level necessary for previous generations to defeat, in quick succession, the Great Depression, Mussolini, Hitler and Hirohito. By 2053, it is expected to reach 180% of GDP.

The U.S. Treasury Department, in a report released earlier this year, said projected federal deficits for the next 75 years have a present value of $80 trillion in today’s money. This represents almost 400% of GDP.

Nothing to see here, friends. Move forward.

Oh, and that doesn’t even include interest charges.

Strauss and his fellow Appleseed mutual fund managers recently shared this in their annual letter to investors. They noted that volatility in the U.S. bond market has tripled over the past two years.

The reason? American deficits. “It appears to us that colossal federal deficits are putting pressure on the ability and/or willingness of investors to absorb the huge and growing Treasury issuances that are taking place,” they write.

Foreigners, especially the Chinese and Japanese governments, are no longer buying like they used to. The Fed, another former buyer, is now selling large quantities of Treasuries. Meanwhile, the federal government is in the midst of a “borrowing crisis,” Strauss and his fellow managers wrote, “raising $1.7 trillion in 2023 (to date), a whopping 80% increase over 2022.”

Meanwhile, they added, the federal government – ​​almost alone among major borrowers – has failed to take full advantage of the low interest rates created by the pandemic by refinancing all of its debts at long-term rates. term. As a result, Appleseed executives wrote, “nearly 29% of the federal debt maturing next year will need to be refinanced from near zero cost to an interest cost of 4.8% to 5 .6%, depending on the duration. of bonds auctioned.

In 2022, only 8% of federal spending went to interest on the national debt. This year it will be 14 percent, more than is spent on the Department of Defense or Medicaid. On the current trajectory, within 30 years this figure will reach almost 40%.

When I spoke to Strauss, he doubled down on assumptions that were difficult to criticize. Given the current state of our political system as a whole, there is really only one way out of this conundrum.

Inflation.

“No one is going to cut military personnel. We are fighting two wars,” he said. “We’re not going to cut Social Security and Medicare because (politicians) want to be re-elected. What’s going to happen is the only option is inflation.”

While Fed Chairman Jerome Powell wants inflation to fall, the rest of the establishment wants more. They need it. Inflation is the only way to square the circle. This reduces the real value of the U.S. national debt in terms of real purchasing power.

It’s no coincidence that one of the ways people in Washington want to cut Social Security benefits while pretending not to is by messing with inflation calculations. Your benefits will increase every year, but prices will increase even more.

Over the past two years, the national debt has increased by 15%, measured in U.S. dollars. But at the same time, these dollars have lost about 15% of their purchasing power.

There is no magic involved. This circle is only square because someone loses. That someone: investors in US Treasury bonds.

As we have seen.

And corporate bonds face a similar challenge. BAA-rated corporate bonds currently offer an interest rate less than 2% per annum higher than the 10-year Treasury bill rate. By historical standards, this is a small gap. If you think 10-year Treasuries aren’t a bargain, the same goes for corporate bonds. Perhaps more so, because if we face a recession or financial crisis, they are likely to be hit, as happened in 2008 and 2020.

Where does this leave investors? Even though Powell promises to do whatever it takes to curb inflation, the rest of the establishment needs it. You have to imagine that there is a good chance that they will get what they want – with the tacit connivance of voters, who also want their share of the butter.

As during the inflationary period of the 1970s, energy stocks could do well. Agricultural and mining stocks could do well. Real estate could do well. Gold could do well. Inflation-protected bonds could do well. Stocks can perform well, especially in companies with strong pricing power. If this scenario plays out, the only asset likely to perform very poorly would be long-term Treasury bonds.

Something worth trading for a rally? Of course. But something “safe” and “risk-free?” No chance.

Read also : How to use TIPS to build retirement wealth

And: 5% CDs and savings accounts are great, but “you’re going to have to pay a lot of it back in taxes.” Here’s how to prepare.