Yield spread suggests diminished odds of a recession in the next 12 months

All yield spreads calculated as 10 year less 3 month yield except Mexico (5 year less 3 month).

Historical time period begins: U.S. 1967, Eurozone 1970, Germany 1970, UK 1970, Sweden 1970, Mexico 2000.

VIX Term Structure

Why are Treasury Bonds the Ultimate Safe Haven?

The last 10 years have exposed a very important reality for any global asset allocator – US Treasury Bonds are the ultimate safe haven investment.  For decades we have heard stories about how gold, silver, real assets or other types of financial instruments would serve as the “safe haven” investment during times of crisis.  Many of these stories were based on mythical ideas about the coming collapse of fiat money or the bankruptcy of the US government.  There have also been endless discussions about the coming collapse of the T-Bond market due to a “bond bubble” or the end of QE. But every time the global economy encounters a hiccup it is T-Bonds that investors demand.

Tadas Viskanta wrote a very good piece about how T-Bonds tend to perform well during times of market uncertainty, but I wanted to take a more operational approach because I think this can be explained in a very simple way.  Importantly, running performance backtests doesn’t help us much here because the global economy is dynamic and the current state of T-Bonds as a safe haven is something that is not guaranteed to persist simply because it has been true in the past.  Byunderstanding the modern monetary system and taking a more operational perspective we can better understand why T-Bonds are so unique within the global economy.

The primary reason that T-Bonds are the world’s financial asset safe haven is a function of the US government’s tremendous revenue stream.  With the USA generating 22% of global output the US government has the ability to tax more output than any other safe haven entity.  In short, the US government has the largest high quality income stream in the global economy.  Interestingly, the US government is the only entity in the world that issues a liability that is attached to such a large and reliable income stream.  China, for instance, issues bonds, but we can’t trust their economic data let alone the financial instruments they issue. Europe would be the US equivalent except for the fact that they don’t issue a supra-national liability.  Instead, each country within the EMU issues its own liabilities and the safety of those individual liabilities has come under serious question in the last few years.

The main point is quite simple though.  When people want to protect their financial assets they can’t, in the aggregate, “get rid of them” so they necessarily deviate to the largest high quality income generating entity in the world.  For the investor who properly weighs their risks between maintaining purchasing power and permanent loss risk the T-Bond becomes the obvious choice since it provides you with safety characteristics similar to cash, but protects you against inflation better than cash.  But most importantly, it gives you access to the largest high quality income generating liability issuer in the global financial system.  This could change going forward and very likely will at some point, but for now, this remains an operational reality resulting from the USA’s unique position as the highest quality output producer with a federal government that can generate income from that underlying output.