Something special happened today, or to be precise, did not happen. As Israel started its new military campaign against Iran, all risk assets in financial markets started to dive, from stock futures to crypto. Understandably, oil prices started to spike in what can potentially become a “VAR shock” event if they continue increasing at this pace. A VAR shock in financial markets refers to a situation where the actual losses of a portfolio or financial institution exceed its predicted Value at Risk (VaR) threshold over a specified time horizon and confidence level. What about the so-called “safe assets”? A lot of money immediately rotated into gold today, no surprise here, that is set to break new all-time highs soon, pushed higher by strong tailwinds such as monetary debasement and geopolitical instability. However, one asset isn’t behaving as everyone would have expected given historical precedents in similar situations: US Treasuries.
US Treasuries have always been the epitome of “risk-off” assets where investors looked for a safe place to park capital in times of uncertainty, especially geopolitical ones. While in the past the events unfolding today would have triggered a strong capital rotation from risk assets to US Treasuries, this isn’t happening today. Is this a Minsky moment for US Treasuries?
Following President Trump’s tariff announcement on April 2, 2025, yields initially fell on growth concerns but quickly reversed to spike toward 4.6% within days due to stagflation fears (inflation + growth slowdown). Bond volatility (MOVE Index) at that time surged from 90 to 140, reflecting chaotic price action. During a U.S.-China tariff standoff back in early March, the 10-year yield plunged from 4.8% to 3.9% late in the week, but then afterward spiked to 4.22% in a single day. This “wrong-way move” defied typical safe-haven behavior already at that time; now we have three strong instances in a few months pointing towards a dramatic paradigm shift.
What are the key drivers we can identify as a cause of this shift?
- Safe-Haven Inefficacy: Recent events show Treasuries increasingly failing as safe havens. For example, during the April 2025 tariff shock, yields rose alongside equity sell-offs, with gold outperforming bonds.
- Stagflation Dominance: Geopolitical shocks now trigger competing forces: lower yields on growth fears vs. higher yields on inflation/tariff impacts. The latter often prevails.
- Technical Pressures: Events like the April 2025 “bear steepening” (short yields falling, long yields rising) reflect hedging unwinds and liquidity strains, overshadowing initial flight-to-quality bids.
- Increasing US Debt and Deficit: The “big beautiful bill” that relied on projections forecasting a significant increase in US revenues due to tariffs to cover rising US debt costs, falling domestic taxes, and new spending programs with the ultimate goal, on paper, to decrease US deficit and debt growth is being strongly questioned. While the goal has been set to 3 trillion USD in revenues from tariffs, the US only collected 22 billion USD in May. Yes, a record high, but even assuming the US will successfully close a significant number of trade agreements in the coming weeks, this amount will likely fall significantly short of the initial projections.
At this point, USD’s short-term weakness shouldn’t surprise anyone anymore; if investors, especially foreign ones, are now reconsidering buying US Treasuries, that implies a lower demand for USD too, which is needed to purchase them. Putting all together, we now have rising oil prices, falling USD value, and sticky high yields that require deficit spending to be repaid. How do you think all these factors will impact US inflation on top of the building pressure on consumers triggered by the new tariff regime that prompted many large corporations to already announce significant price increases?
For all those who still claim tariffs are deflationary, I posted this explanation on X:
“Tariffs bring down revenues and margins if consumers cannot absorb price increases, but price increases stick, and that’s called inflation. In a world where companies are forced to keep growing revenues to inflate their stock prices, they will keep increasing prices to make up for the decrease in demand, squeezing that portion of consumers that will be able to absorb higher prices.
Not sure why economists struggle to understand this, maybe because they don’t ‘see it’ in the officially adjusted data spoon-fed to them and no one in Wall Street wants to pick up an argument with the administration in charge on the matter since that is bad for business.”
The Fed is clearly more and more in a tough spot because while the overall environment demands a hike in Fed Funds rates to fend off the inflation risk, on the other side, the financial stability of the current system is coming into question and the Fed cannot afford to let the whole structure fall apart. Similar to the BOJ, the Fed printed itself into a corner because, while the US government desperately needs rate cuts to decrease its debt costs due to the trillions of debt front-loaded in T-bills by Janet Yellen, the same government also needs the Fed to resume QE to monetize its deficit spending and make up for the gap created by private investors decreasing demand. Cutting rates and resuming QE, something the current US administration is strongly demanding, will be equivalent to throwing gasoline on the inflation fire and adding more pressure on yields already in a strong upward trend. Increasing rates and tightening financial conditions will surely impair financial stability considering how reliant the whole market, especially stocks, has become on easy money.
Frankly speaking, I have no idea how the Fed can get out of this mess, how the US government can restore confidence in US Treasuries, and how the financial system, especially banks, will be able to deal with the growing pile of toxic assets in its books while holding razor-thin capital they were allowed to erode during the years due to fat dividend distributions and aggressive stock buyback programs. Gold is the obvious winner in the long term no matter the developments in the short term; Bitcoin and other assets characterized by intrinsic limited supply are set to benefit too, as the current price jumps in Platinum and Silver highlight. Surely over-inflated stocks will be the biggest losers followed by credit, especially on the Commercial Real Estate and Consumer front.
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