Treasury Secretary Scott Bessent’s plan to buy back government bonds and hold yields down backfired on Wednesday, as yields rose anyway. Markets are reflecting reality: The government’s budget is a mess, and politicians have no plans to significantly curb spending.
For years, financial discourse has been built on the bedrock belief that U.S. government bonds are the world’s safest assets. When economic problems arise, they spark a “flight to safety” as investors buy U.S. bonds. Commercial banks, central banks, pension funds and life insurance companies around the world buy U.S. bonds for the rock-solid assurance that they will pay reliably over the long haul.
Investors paid extra for U.S. government debt compared with other governments’ debt because it was seen as the most secure. That meant the U.S. government could finance its debt more cheaply than other governments.
Stanford finance professor Hanno Lustig argued in an August paper that these basic premises are no longer true.
Rising government bond yields are common across the developed world, as most rich countries have rising debt loads and a shrinking ability to make good on their promises to bondholders. And the markets are increasingly treating the United States like any other rich country. Lustig found that the premium investors used to pay for U.S. bonds over debt from governments in other advanced economies has almost completely eroded.
Since 2022, Lustig found that investors haven’t even been paying a premium for U.S. government bonds over the highest-rated corporate bonds when adjusted for the corporations’ credit risk. This is not normal.
Another change that happened in 2022: Stock prices and bond prices, which are the inverse of bond yields, became positively correlated. That means as stock prices fall, bond prices also fall, and vice versa. If the “flight to safety” were still operative, the reverse should be true: Investor demand for bonds should rise if stock prices fall, which would drive up the price of bonds.
Lustig gave the example of President Donald Trump’s “Liberation Day” tariffs announcement when stock prices and bond prices fell together. The same thing happened on Wednesday, on a smaller scale, in reaction to Bessent’s announcement.
These signals are not determinative on their own that government bonds are no longer safe assets in general. But they are warnings from the market, one that politicians are so far ignoring — or, in Bessent’s case, seeking to stifle rather than address.
By ignoring these warnings, politicians are making the situation worse. By issuing so much debt — the deficit in each of the past three years was larger as a share of the economy than any year of the Great Depression — the safest buyers of U.S. bonds have more than enough, so less-safe buyers are stepping in.
In this case, that means hedge funds. Treasury analysts have noted this year that hedge funds are buying more government bonds than in the past, and now own more than $2 trillion in U.S. sovereign debt, over 6 percent of the total.
That’s fine in and of itself. But hedge funds are a different kind of buyer from the usual U.S. bondholders. They borrow lots of money to make speculative investments. That approach is much more volatile than a central bank sitting on its assets.
If hedge funds’ investments don’t work out, the funds could need to sell their bonds quickly to raise cash. A fire sale of U.S. bonds by hedge funds would drive yields even higher, raising the government’s costs and potentially destabilizing global markets.
The $1.8 trillion in new debt from the 2025 budget deficit was bad enough. But people had to buy $11 trillion in U.S. government bonds last year because the Treasury Department also had to refinance $9 trillion in old debt that rolled over. Given that politicians aren’t moving to close the deficit over any time horizon, investors are — reasonably — demanding higher yields to compensate for Washington’s profligacy.
U.S. sovereign debt has already been downgraded by all three major rating agencies: S&P in 2011, Fitch in 2023 and Moody’s in 2025. This week, investors are making it even clearer that they don’t believe U.S. bonds are as safe an asset as they once were. Five years of above-target inflation, as government continues to inject extra money into the economy, has voters upset. The last people to realize something’s wrong, it seems, are the politicians.
The post Government bonds are safe assets, right? appeared first on Washington Post.
