End of an Era? Navigating the US Deficit, Debt and Dollar

Monika Carlson: The US bond markets have been volatile lately. Investors are worried about tariffs; they’re worried about the fiscal deficit in the US; and they’re also worried about the potential loss of the safe-haven status for the dollar and US Treasuries. There’s a lot to unpack here.

First, tariffs are inflationary in nature, especially in the near term. Then the One Big Beautiful Bill Act is expected to increase the fiscal deficit by anywhere from $1.5 to $3 trillion over the next decade. That’s because the tax cuts embedded in it are greater than the potential savings.

And so, with more Treasury supply and with investors continuing to worry about the fiscal health of the United States, we could see the term premium on Treasury yields increase because investors may require higher compensation for higher risk.

So, taking all these issues into consideration, what are your expectations for the Treasury market?

Fahd Malik: Politicians will be politicians, and there’s going to be constant news flow coming out of Washington. So, what investors need to focus on is how to separate noise from signal.

So, for instance, we know the tariffs in the near term will be inflationary, but the long-term impact of tariffs would be less pronounced. So, if you’re an investor looking at a one- to three-year kind of investment horizon, then you should look through the volatility that’s being induced on the back of tariffs.

Similarly, on fiscal, while debt matters, the level at which it becomes problematic for the Treasury market is not clear, especially if the US dollar is the reserve currency of the world. Our analysis shows that there’s very little relationship between debt levels and Treasury yields across the globe.

MC: Also, US Treasuries remain one of the most liquid and creditworthy instruments globally. Other markets simply aren’t big enough or liquid enough to replace them as the first choice for safe-haven assets. And so, even if foreign investors pull back somewhat, Treasuries are still going to have a place in the global asset allocation. We’ve seen that recently. The auctions have been well subscribed, which speaks to continued demand for the sector.

FM: Absolutely. And US Treasury Secretary Scott Bessent is committed to keeping Treasury yields lower. Also, if you go into a growth slowdown later in the year, we think the Fed can actually cut more than what the market is pricing in, and this should support the Treasury market.

MC: The growing deficit also puts pressure on the US dollar. What is your perspective on that?

FM: We think the US dollar retains its reserve currency status—simply because, like the Treasury market, there is no viable alternative.

MC: Where do you think Treasury yields are heading then?

FM: We think there’s going to be near-term volatility, but eventually, Treasury yields should trade in line with their fundamentals, which is where do we think inflation is going to be, and where do you think real rates are going to end up

Currently, these two factors point to 10-year Treasury yields trading close to 4%, which is lower than where they are right now.

MC: What words of wisdom do you have for investors looking to manage their Treasury allocation?

FM: Investors need to look through the volatility that we are seeing in the Treasury market. Use volatility to generate returns.

So, for instance, if you bought Treasuries when yields went up, and you sold Treasuries when yields went down in the last three years, you did okay. Also, it matters where you take that duration risk. So, for instance, if you’re buying the intermediate part of the Treasury market, we think that’s shielded from all the fiscal noise, yet at the same time, if the Fed cuts, you can benefit greatly.

MC: All of this underscores that Treasuries are a critical anchor in asset allocation and can provide a really important offset in times of market stress.