The Treasury market is one of the pillars of the global financial system. This is due to its size and liquidity, its role in setting borrowing conditions, and the safety that these securities provide.
However, the announcement of so-called 'reciprocal' tariffs last April caused turmoil in the market, reminding us that Treasuries had become more sensitive to periods of stress. In other words, the liquidity and safety offered by these securities in the event of a shock had reduced somewhat. We identify three structural factors that explain this, and US policy shows no sign of addressing them.
Firstly, the colossal size of the US federal debt has reduced the reliability of US Treasuries as a safe haven. However, the administration's fiscal policy is unlikely to enable a recovery in public finances. Assuming all other factors remain equal, tariff revenues will certainly offset a significant proportion of the tax cuts contained in the One Big Beautiful Bill Act. However, their negative impact on economic activity will counterbalance some potential positive effects of the tax cuts.
Ultimately, the public deficit is likely to remain high over the next few years, at between 5% and 6% of GDP — a level unprecedented outside times of war or recession. Furthermore, the US public debt ratio is likely to rise beyond its historic high of over 100% of GDP for federal debt held by the public. This implies an ever-increasing supply of securities that needs to be absorbed in a context of rising interest rates.
The second factor that has undermined the safe-haven status of Treasuries relates to the creditors of the Federal Government. The profile of these creditors has changed significantly over the past 20 years. The proportion of federal debt held by foreign central banks has declined, while that held by hedge funds has increased. However, the short-term strategies employed by hedge funds have made US Treasury securities much more vulnerable to periods of stress.
From this point of view, the Trump administration's policy is not without risk either. The Genius Act, enacted this summer, will stimulate demand for federal paper from stablecoin issuers. However, this is likely to have only a modest effect on overall net demand for government securities and could increase the vulnerability of Treasuries in times of stress. Rumours of taxes targeting non-resident investors and threats to the Federal Reserve's independence could also destabilise the situation.
Finally, the third factor weakening the status of Treasuries is banking regulation. Admittedly, US regulators will soon relax the leverage constraints imposed on the largest US banks. This will strengthen banks' ability to facilitate the Treasuries market and will likely reassure investors. However, the beneficial effect may be short-lived. As long as federal debt continues to rise, banks will need to devote more of their balance sheet space to their role as intermediaries.
In conclusion, to preserve the status of Treasuries, the US administration should endeavour to dispel concerns, particularly those relating to the sustainability of federal debt. Otherwise, Treasuries will certainly remain central to investors' portfolios, but accompanied by a higher risk and term premium.
