The medium-term trend of major asset classes depends on how the United States manages its debt

Traditionally, U.S. Treasury bonds are considered risk-free assets, and their yields serve as a pricing anchor for global assets. However, in recent years, some phenomena may indicate a weakening of U.S. Treasuries' pricing power over major asset classes. The correlation between U.S. Treasuries and other assets is no longer significant, and even reversals in correlation have occurred, leading to challenges for the pricing framework of major assets centered around U.S. Treasury yields. Specifically:

1) Gold shows a characteristic of rising with U.S. Treasuries but not falling with them. Historically, gold has maintained a strong correlation with U.S. Treasury yields, especially real U.S. Treasury yields, meaning that the U.S. Treasury index and gold prices "rise and fall together." However, with central banks accelerating gold purchases and the recent rise in U.S. Treasury risk premiums, the trends of the two have begun to diverge, with gold and the U.S. Treasury index shifting from a positive correlation to "uncorrelated," and gold exhibiting a characteristic of "rising with U.S. Treasuries but not falling with them."

2) Rising U.S. Treasury yields do not necessarily correspond to a stronger U.S. dollar. According to the interest rate parity condition, an increase in a country's interest rates often leads to capital inflows, which should result in the appreciation of that country's currency. However, since April, the 10-year U.S. Treasury yield has risen significantly to a high of 4.5%, while the U.S. dollar index has continued to weaken, dropping to its lowest level in nearly three years.

3) The high U.S. Treasury yields no longer significantly suppress the valuation of global equity assets. Generally, rising U.S. Treasury yields tighten U.S. dollar liquidity, putting pressure on equity assets, especially emerging market stocks. However, since 2022, although U.S. Treasury yields have risen and remained high, the valuation of global equity assets has continued to recover, particularly evident since April of this year.

We believe the main reasons for the above phenomena are:

1) From a pricing logic perspective, the current rise in U.S. Treasury yields is due to the continuous deterioration of the U.S. debt situation, leading to a downgrade in sovereign credit ratings, manifested as a significant rise in term premiums and CDS, essentially reflecting country credit risk. The main triggers are the unexpected fiscal expansion of the U.S. tax reform bill and Moody's downgrade of the credit rating, resulting in a rapid short-term manifestation of medium- to long-term debt sustainability issues. This is more about the problems with U.S. Treasuries themselves rather than traditional macro variables dominating, leading to a decoupling of correlations with other assets, negatively impacting all U.S. dollar assets and positively impacting gold.

2) From a liquidity flow perspective, the rise in U.S. Treasury yields no longer signifies a tightening of global liquidity but rather a reallocation of funds between U.S. dollar and non-U.S. assets. Since the beginning of this year, the exceptionalism of the U.S. has been shaken, with a noticeable loosening of overseas capital inflows into the U.S., decreasing the relative attractiveness of U.S. dollar assets. After funds flow back to domestic markets, liquidity in non-U.S. markets has actually become relatively loose In the short term, EPFR data shows that the scale of global capital inflows into U.S. Treasuries has significantly slowed down; in the long term, the decline in the U.S. current account deficit may be accompanied by a decrease in the capital account surplus, coupled with sovereign rating downgrades, which is likely to reduce overseas investors' interest in U.S. Treasuries.

3) Looking ahead, the dominant factors affecting U.S. Treasury yields are constantly switching between credit risk, fundamental expectations, and investor risk appetite, leading to a relatively chaotic correlation with other assets. According to the pricing framework for long-term U.S. Treasuries proposed by Bernanke, there are three main influencing factors: future short-term real interest rates + inflation expectations + term premium. The first two are more related to macro fundamentals, which have not changed significantly recently, while the term premium is more dependent on U.S. government credit risk and the supply-demand structure of government bonds, which are the dominant factors driving the recent rise in U.S. Treasuries. The switching of dominant factors can also lead to changes in the correlation between U.S. Treasury yields and other assets. For example, when economic improvement raises real interest rates, it is bearish for gold and bullish for U.S. stocks; however, when the term premium rises, it is bullish for gold and bearish for U.S. stocks. Therefore, the correlation between U.S. Treasury yields and other assets needs to be viewed dynamically.

From the perspective of asset allocation strategies:

First, the U.S. fiscal deficit is likely to rise rather than fall, and countries tend to expand fiscal policies to hedge against tariff shocks, with credit risk continuing to disrupt the market. There is an urgent need for new alternatives to dollar assets, and Japanese bonds may not be a "safe haven." Future attention should be paid to non-U.S. equity assets such as European stocks, Hong Kong stocks, and A-shares, which are supported by fiscal expansion + monetary easing + foreign capital inflows; sovereign bonds with lower government debt levels, such as German bonds; and other supply-constrained assets like gold, cryptocurrencies, and copper.

Second, the current term premium (especially credit risk) has become an important factor driving long-term interest rates upward, and the correlation between major asset classes is significantly different from when driven by fundamentals. The correlation between U.S. Treasuries and U.S. stocks has also begun to become chaotic. The classic 60/40 stock-bond portfolio and risk parity strategies may face the risk of failure, with a focus on global diversification + alternative assets, such as gold and U.S. stocks beginning to show negative correlation. Since 2025, the performance of the 60/40 stock-bond portfolio and risk parity portfolio, based on the negative correlation between stocks and bonds, has been average, while increasing the strategic allocation of gold in the asset portfolio can significantly improve the Sharpe ratio

Third, in response to the turbulence in the bond market, fiscal and monetary authorities may stabilize the market through various means such as adjusting the pace and structure of bond issuance, and adjusting the structure of central bank holdings of government bonds. If short-term sentiment is overly pessimistic, it may actually present a better trading opportunity. To avoid amplifying bond market volatility due to changes in long-term bond supply, the U.S. Treasury has kept the issuance of medium- and long-term bonds stable, with financing gaps more supplemented by more flexible short-term government bonds, and is considering strengthening the bond repurchase program to soothe market sentiment. In addition, after a significant rise in the interest rates of Japan's ultra-long bonds recently, the Japanese Ministry of Finance is considering adjusting its bond issuance plan to drive interest rates down.

Fourth, from a medium- to long-term perspective, the U.S. government's approach to debt will become an important variable affecting the medium- to long-term trends of major asset classes. Changes in government leverage can be referenced by the following formula:

Where d is the government leverage ratio (debt/GDP), r is the nominal debt interest rate, g is the real GDP growth rate, π is the inflation rate, and f is the fiscal deficit rate. Different debt management approaches correspond to different asset performances:

1) Growth-oriented debt management: Debt continues to expand, but the real GDP growth rate exceeds the rate of debt expansion. The potential path is to wait for AI redemption to enhance labor productivity, with asset performance being strong stocks and weak bonds. This path is also the debt management method recently claimed by Bessenet, but the risk lies in the possibility that if labor productivity does not significantly improve, investment returns may decline, and continued debt expansion could lead to sustained damage to U.S. dollar credit. In a scenario where U.S. bonds weaken, U.S. stocks may not necessarily be strong.

2) Inflation-oriented debt management: Debt expansion does not lead to productivity improvements, only manifesting as growth in terminal demand and rising inflation. The nominal GDP growth rate exceeds the nominal debt expansion rate, resulting in a decrease in the nominal debt leverage ratio. For example, during the high inflation period in the U.S. from 2021 to 2023, the government's nominal leverage ratio was passively reduced. U.S. stocks and gold performed better than U.S. bonds, but the real exchange rate of the dollar was damaged, leading to a decline in the real purchasing power of creditors.

3) Debt monetization: Central bank monetary easing, through lowering interest rates, QE, and other means, in conjunction with government debt expansion, leads to liquidity easing resulting in strong performance in both stocks and bonds, while the dollar is weakened. This path is a debt management method guided by MMT theory, typical of the U.S. during the COVID-19 period and Japan under Abenomics, but it may lead to high inflation.

4) Tightening-oriented debt management: Strengthening fiscal discipline, reducing deficit levels, sacrificing short-term economic growth to address medium- to long-term debt issues, with asset performance being weak stocks and strong bonds, while the dollar remains relatively stable. However, under U.S. voter politics, the election cycle causes the ruling party to lack the motivation to formulate and implement long-term spending reduction plans. In the medium to long term, reducing reliance on government debt and shifting towards economic reforms and other endogenous growth methods can achieve more sustainable development, such as the Clinton administration's compression of welfare spending through the Balanced Budget Act of 1997, leading to four consecutive years of budget surplus in the U.S With GDP remaining robust, the US stock market has entered a four-year bull market.

Note: This article has been abridged.

Authors of this article: Zhang Jiqiang, Tao Ye, et al., Source: Huatai Securities Fixed Income Research, Original title: "[Huatai Asset Allocation] When US Treasuries No Longer Act as the 'Pricing Anchor'"

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