Do Fiscal Concerns Undermine the Role of US Treasury Securities as Core Portfolio Diversifiers?

No. US Treasury securities are likely to remain among the most effective diversifiers during periods of equity market stress. While US fiscal and policy concerns have contributed to recent volatility, the attractive attributes of US Treasury securities should sustain global demand and support their central role in multi-asset portfolios. However, no single asset is a perfect hedge in every environment. Maintaining high-quality bond allocations in line with policy remains prudent, both tactically and as a long-term portfolio anchor, but there is a case for diversifying beyond US Treasury securities from a portfolio construction perspective.

Moody’s recently downgraded US government debt from Aaa to Aa1, citing persistent, large fiscal deficits and rising debt burdens. While the downgrade reflects fiscal deterioration, it is unlikely to have a lasting market impact. For one, the United States faces no solvency risk, and Moody’s still considers its credit strength exceptional. In addition, among highly rated countries, changes in credit ratings and debt levels show little long-term correlation with changes in government bond yields, which respond more to macroeconomic fundamentals. However, the downgrade coincides with a proposed budget bill that could further widen deficits and increase scrutiny of the US fiscal and economic outlook.

Congressional Republicans are negotiating a budget bill that extends expiring tax cuts, enacts new tax cuts, and reduces spending. The current House version expands the primary fiscal deficit by $3.4–$5.0 trillion over the next decade, according to the Budget Lab. Most of this increase comes from a widely expected extension of tax cuts ($4 trillion), while higher tariff revenues could offset most of the new costs. The Budget Lab estimates tariffs introduced in 2025 would raise $2.7 trillion over ten years, reducing the net deficit increase to $0.7–$2.3 trillion. While their impact may be delayed or limited after a recent federal court ruling struck down most of the new tariffs, the Trump administration retains considerable authority to impose tariffs under current law. As a result, the United States’ average effective tariff rate will likely increase significantly, and tariff revenues should remain sizable. If tariffs are curtailed, the net fiscal and economic impact may be slightly more expansionary, but it will still be more limited than the bill’s headline figures suggest.

Bond markets have been volatile this year, with concerns shifting from growth to fiscal and supply risks. Yields fell early in the year as tariff uncertainty rattled global markets, restoring the negative stock-bond correlation that underpins US Treasury securities’ role as a diversifier. Still, this relationship has been inconsistent. At one point, US Treasury securities briefly sold off alongside equities and the dollar—a rare episode that raised concerns about foreign selling. Although foreign investors have gradually reduced their exposure over time, they significantly increased their holdings in first quarter 2025, even amid heightened US fiscal and policy uncertainty.

Recently, long-dated yields have risen sharply across developed markets, driven by easing trade tensions, improved risk sentiment, and heightened fiscal and policy uncertainty. In the United States, 30-year Treasury yields jumped over 20 basis points in recent weeks, nearing 2023 highs. Back then, the bond market faced similar pressures—Fitch had downgraded US debt after another debt ceiling standoff and inflation was sticky. Today, however, inflation is much lower, the economy appears cooler, the yield curve has steepened, and the term premium is elevated. The US ten-year term premium recently reached 0.92%, its highest in a decade and just below its 1.1% average since 1990. While a one-time bump in inflation from tariffs and continued budget headlines could push yields higher in the near term, the government still has tools to manage the long end of the curve, such as relaxing leverage requirements for banks or issuing more short-term debt. Further, the broader macro environment does not necessitate significantly higher long-dated yields, which should help support demand and limit further increases.

Looking at the bigger picture, despite recent fiscal and policy concerns, the United States’ status as the world’s largest economy, deepest financial market, and reserve currency suggests US Treasury securities will likely remain among the most effective diversifiers during future periods of equity stress. Since 1973, US Treasury securities have appreciated in ten out of the last 11 global equity bear markets, with a median return of 5.6%. Still, no “silver bullet” macro hedge exists—certain environments, such as stagflation or periods of broad US asset or dollar weakness, can challenge even US Treasury securities. For example, while US Treasury securities appreciated during the drawdown in global equities earlier this year, they returned only 2.0%, which is less than usual and trailed both unhedged global ex US Treasury securities (2.1%) and gold (2.5%).

Ultimately, US Treasury securities continue to offer attractive diversification benefits and should remain a core anchor in portfolios. However, recent developments highlight the importance of not relying on any single asset as a universal hedge. Investors can strengthen downside protection by pairing US Treasury securities with other defensive assets, creating more resilient portfolios across diverse market conditions.