Rick Patel

Recent market volatility and news flow driven by geopolitical and trade issues have led some to question the US Treasuries’ status as a safe-haven. While there are valid concerns around the recent US credit downgrade from Moody’s, the size of the US fiscal deficit, and questions around overseas demand for Treasuries, we believe that this fear is overstated.

To begin with the first point, the US had been on ‘negative watch’ from Moody’s for around 18 months prior to the downgrade over concerns around the fiscal landscape. So the downgrade was not necessarily unexpected. In addition to this, Moody’s has recently highlighted the ‘exceptional credit strengths the US still has, including ‘the size, resilience and dynamism of its economy and the role of the US dollar as the global reserve currency.’ The size, liquidity and strength of the US market is unparallelled and irreplaceable and we expect US Treasuries and credit to remain a key allocation for investors globally.

When it comes to the fiscal deficit, while we are concerned about the increase here given projections of a deficit of around seven per cent over the next few years, it is important to break this number down. In the most simplistic terms, this around seven per cent forecast can be halved into around 3.5 per cent from interest payments on Treasury debt and around 3.5 per cent from fiscal spending. As we move closer to a potential series of Fed rate cuts, interest expenses will fall, therefore reducing the size of the deficit. This would limit concerns from bond markets about the debt to GDP ratio. What concerns us more, and has done for quite some time, is that in a scenario where the US economy weakens, any fiscal support is now likely to be much smaller and less forthcoming than in previous crises, as the government will simply have less fiscal headroom to spend.

With deficit projection this high, it is no secret that the US will need to issue heavily in the bond market. Understandably, there has been some concern that recent geopolitical events have limited overseas demand for US Treasuries. As a starting point, we would highlight that the trend of Japanese and Chinese institutional investors slightly reducing their allocation to the US has already been taking place for some years now, with a limited impact on overall demand.

In addition, the thing that provides us with a high degree of comfort in the resilience of demand for US Treasuries going forward is the composition of domestic wealth. For instance, compared to the rest of the world, US households have a much higher allocation to equities, so there is material capacity for US domestic investors to increase their allocation to fixed income. To put this in perspective, a one per cent increase in US domestic allocations to fixed income would likely fund the increased US Treasury issuance for the next two to three years. There are numerous ways this small asset allocation shift could happen. An organic increase is likely, with attractive yields on US Treasuries inducing pensions, insurance and multi manager accounts to increase their allocations, limiting the need for individual investors to actively switch, or there may be some form of tax incentive from the US government.

US households’ allocation to equities is very high relative to other countries

Source: Fidelity International, Goldman Sachs Global Investment Research. June 2025.

Whilst there are many unknowns ahead and some of the concerns around the US are just, we remain convinced that should the US economy weaken enough to trigger a flight to quality, US Treasuries are well positioned relative to risk assets. The fact is there are few viable alternatives to Treasuries, and we expect a very limited change in demand in the long term.

By Rick Patel, portfolio manager

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Rick Patel

Since the recent market volatility, there has been concern that US Treasuries have not been acting as a hedge for equities. Whilst the intraday volatility in rates has been severe, it is important to add some context and perspective to these moves.

Although Treasury yields have been volatile, overall moves have been more contained. At the end of April, the US 10-year is ~10bps higher than at the beginning of April, which is still ~50bps lower than YTD highs in January. Similarly, 30-year yields have moved sharply and are ~20bps higher MTD but flat on a YTD basis. In recent history, the US has relied on foreign investors to fund its twin deficits, but with the US at the centre of a tariff volatility storm, global investors are demanding more compensation to invest in Treasuries because of heightened uncertainty and increased potential for a US slowdown.

Ultimately the extent of the slowdown ahead will be a function of how US corporates respond to tariffs and whether they choose to absorb impacts in reduced profit margins or pass on price increases. Many S&P 500 corporates are currently announcing earnings, and this will provide some insight into how firms are navigating the impact, which will help to shed light on the magnitude of the slowdown ahead. 

On the trajectory of the US labour market, much of the strength in 2024 came from healthcare and government sectors. Interestingly on the former, recent temporary employment leading indicators have pointed to a steady decline, with the demand for nurses falling on a year-on-year basis for the first time in a while. The government sector also continues to undergo its own challenges which should weigh on payroll numbers going forward.  

In our view, the bottom line is that the Fed Funds rate of 4.25% is too high relative to expectations of limited structural growth and inflation rates going forward. The Fed appears reluctant to cut rates based on their recent commentary and are likely to require a catalyst to do so. A deterioration in the labour market might be a catalyst as they look to protect the maximum employment side of their dual mandate. 

From a downside risk scenario perspective, if there is a recession with immediate job losses, the Federal Reserve will have to cut far more aggressively than the market is expecting. To put this into context, in this scenario, multiple 25bps cuts over subsequent meetings would do very little to support the US real economy, given that this cycle is unique due to the delayed nature of monetary policy transmission. For instance, around 75% of US households have a fixed-rate mortgage below 5% as many refinanced during the pandemic era of low rates, which is materially lower than the current market mortgage rates. Rates for smaller business are also punitively high, which is significant given that they employ over 50% of American workers. Clearly the market is not currently pricing in this scenario, despite it being a potential a tail risk. In the event this scenario does materialise, we would expect a Fed Funds rate below 2% as this would be their only viable pathway to provide support to the real economy.  

There are many unknowns ahead and volatility is likely to persist as the situation around tariffs remains fluid and ever evolving. What we can say with confidence is that in response to this challenging market context, an active and nimble approach to investing is more important than ever. Maintaining a yield buffer through this environment is also key whilst remaining defensive, and one way to do so is through short-dated bonds with attractive yields rather than remaining completely on the sidelines in cash. 

Clearly volatility and uncertain times are difficult from many different perspectives. However, our investment approach suits periods of volatility, and we believe there are opportunities ahead to deliver alpha and build on the strong relative performance achieved year-to-date and post ‘Liberation Day’.”

By Rick Patel, portfolio manager

The post US credit markets amidst rising volatility appeared first on AdviserVoice.

Lawrence Hanson

Fidelity International has launched the Fidelity Global Bond Fund in Australia, jointly managed by Rick Patel, Ario Emami Nejad and Daniel Ushakov.

The Fund invests mainly in investment grade global sovereign bonds and global corporate bonds, but also provides some exposure to global high yield bonds and emerging market bonds. The Fund has an overall average AA-investment grade credit rating*.

Commenting on the launch, Managing Director, Lawrence Hanson, highlighted growing client interest in, and demand for, investments in quality government and investment-grade corporate bonds.

“Clients are increasingly seeking alternative investment options with lower risk exposures to complement their current investment strategies. “

“The launch of the Fidelity Global Bond Fund further expands our service offering in Australia, providing investors with investment choice and diversification, and access to our global investment capabilities.”

Global Cross Asset Specialist Lukasz de Pourbaix believes the fund offers a number of benefits for investors in the current environment.

“We’re arguably edging closer to the end of the interest rate tightening cycle. Should central banks begin easing interest rates once inflation is deemed to be under control, this would be positive for bond strategies, particularly those that are exposed to duration risk such as government bonds or strategies benchmarked against the Bloomberg Global Aggregate Bond Index.

Besides regular income distributions, the Fund also offers the potential for higher returns than traditional cash investments over the medium to long term.

“The Fidelity Global Bond Fund is an actively managed portfolio of global bonds. To generate attractive returns, we combine diversified investment positions advised by our in-house fundamental credit research, quantitative modelling and specialist traders.”

“The fund provides a broad and diversified exposure to global bond markets, and we have the ability to allocate exposure to different geographies, currencies, sectors, and maturities to meet the Funds’ return and risk objectives. “

The fund has a suggested minimum investment period of five years and is suitable for investors with a medium tolerance for risk.

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*As rated by internationally recognised rating agencies

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