WASHINGTON – Sept. 28, 2016 – U.S. Treasuries, a direct descendant of the Revolutionary War Funding Act of 1790 and a beloved member of traditional portfolios, died as a safe haven this fall, after a valiant struggle against low bond yields and creeping correlation to stocks.
Born as Liberty Bonds in 1917, U.S. Treasuries faithfully served its country during several tours of duty. Starting in World War I, Treasuries helped finance the cost of war for the U.S. and continued that service through World War II. In 1952, U.S. Treasuries began a second career in diversification.
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Diversification gives Treasuries newfound purpose
For more than 60 years, Treasuries added deeper diversification to stock-only portfolios. This benefitted scores of investors who became less susceptible to the peaks and valleys of the market after the switch to a 60/40 stocks and bonds portfolio.
In times of economic stress, such as the rampant inflation of the 1970s, U.S. Treasuries delivered attractive yields and provided a welcome relief from stock volatility. Beginning in the early 1980s, Treasuries provided savers, retirement investors and professional traders strong total returns from both interest income and capital appreciation.
Even when the economy was hit hard by the credit crisis in 2007, Treasuries provided strong and uncorrelated returns to shaken investors. But repeated doses of quantitative easing and fiscal stimulus, designed to bolster the economy, began to weaken the safe-haven status of Treasuries.
Post-credit crisis economy proves challenging for Treasuries
2014 introduced a new disease that Western society once thought unimaginable: negative interest rates. As quantitative easing continued to spread globally, the long-term prognosis for safe-haven health went from “in remission” to “terminal.” Stimulated by the historic purchase of Treasuries by central banks and quasi-government agencies, lower yields increased duration risk and the forecast became grim.
Then risk-off days that jolted the market out of its sleepy end to summer revealed an uncomfortable question: what does it mean for the market if risk-off includes U.S. Treasuries?
The September 2016 stock market sell-offs and Federal Reserve reluctance to raise interest rates gave the market something to react to after nearly 40 days with little market volatility. But Treasuries weren’t negatively correlated during these moves. Instead, many investors saw red where they thought they had diversification.
Left untreated, Treasuries succumbs to economic ills
Sadly for U.S. Treasuries, sickly bond yields went largely untreated because after the credit crisis, investors searched for yield in a variety of other securities –all of which have even more correlation to the stock market.
Economic doctors hope future policy can revive U.S. Treasuries as a “safe haven” for investors. Until then, U.S. Treasuries are survived by their distant cousin, municipal bonds, as one of the only fixed income securities without positive correlation to the stock market.
Funeral services are not yet set. Reach Janet Yellen, President and Chairwoman of the FOMC, for details.