US losing safe haven status?

A DECADE-LONG belief in US exceptionalism is beginning to fray at the edges. Investors, once unwavering in their faith in the world’s largest economy, are now questioning whether American assets still deserve their safe-haven status.

For more than 10 years, global portfolios have been heavily tilted towards the United States, drawn by its strong economic growth and market-beating returns. But that tide may now be turning.

Mike Riddell, portfolio manager of the Fidelity Strategic Bond Fund, notes that the US dollar has gone from the weakest level in recent history in 2013, to the most expensive on a trade-weighted basis since 1986 by January this year, as a result of increasing allocation to the United States for the past decade.

That narrative, it seems, has reached a tipping point.

A cyclical downturn in the US economy has emerged since January, initially triggering a rally in US Treasuries and a weaker dollar – typical market behaviour when rate cuts are anticipated. But things have since become far more volatile.

“Long-dated US Treasury yields have sharply risen since the beginning of March, which is concerning when risk assets are coming under pressure,” Riddell highlights. In fact, he says, long-dated US real yields have only ever been meaningfully higher than now in the US regional banking crisis in March 2023 and in October 2008.

These aren’t just technical wobbles. There’s something more fundamental taking place beneath the surface.

Focus on tariffs

According to Anthony Willis, senior economist at Columbia Threadneedle Investments, the market focus at present remains firmly on tariffs. While some relative calm has been restored, the earlier part of this month was dominated by wild swings in equities and a dramatic sell-off in US Treasuries and the US dollar.

The combination of US policy unpredictability and the breakdown in confidence has rattled markets, Willis points out.

“It does seem we are seeing something of a regime change taking place in the sense that traditional safe havens in US assets are no longer seen as such, given the unpredictability in US government policy,” he argues.

While inflation expectations have steadied – thanks in part to a 90-day delay in new tariffs and a slump in oil prices – real and nominal yields continue to rise.

“Clearly, higher nominal and real yields aren’t due to booming growth expectations either, given the lurch lower in risky asset prices,” Riddell explains.

Nor is it about inflation.

He says: “Market implied medium- to long-term inflation expectations have slumped to the lowest levels since mid-2020.”

So what’s going on?

It appears that capital is simply fleeing US assets.

“The sharp move higher in longer-dated government bond yields, coupled with a weaker US dollar, looks like good old capital flight. The global ‘bond vigilantes’ are clearly alive and well,” says Riddell.

Capital flight

This flight is particularly problematic for the United States, which is a twin deficit economy, with sustained fiscal and current account deficits.

“Like any twin deficit economy, the United States is reliant on the ‘kindness of strangers’ to fund it,” Riddell states.

And that kindness may be running out.

There’s speculation that foreign investors – perhaps China, or even European and emerging market central banks – are scaling back US Treasury holdings.

“The substantial rally in the euro, coupled with the move lower in German government bond yields, is indicative that some of this move could be European based investors bringing money back home,” Riddell observes.

At the same time, emerging market currencies have been under moderate pressure, which has prompted some to sell down their reserves, mostly involving selling US Treasuries.

Meanwhile, the tariff war between the United States and China has reached a boiling point.

Willis lays it out plainly: “There is a de facto blockade on trade between the two biggest trading partners in the world, with the United States applying a total tariff of 145% and China applying a tariff of 125%.”

These numbers are staggering, especially considering that combined trade between the two countries was US$585bil last year, he highlights.

Even attempts at moderation have failed to stem the damage.

“The pause in the implementation of reciprocal tariffs appears to be a considerable climbdown from the rhetoric of 10 days ago,” Willis says.

Sentiment hit

But the market has already been spooked.

“The Trump administration appeared comfortable with the pullback in equity markets, but cracks in the Treasury market were more unsettling and combined with a further slump in the US dollar suggested that investor faith in the United States was being unsettled,” Willis points out.

This loss of confidence isn’t easily repaired.

“Financial markets are in something of a nervous holding pattern until we have answers to two questions,” Willis says.

“First, the ultimate level of the tariff regime...Second, the status of the US dollar as the reserve currency and US Treasuries as a ‘safe haven’ asset.”

There are also deeper structural issues. For years, the US consumer has played an inadvertent role in funding government debt through global trade.

“If US trade policy succeeds in reducing or even eliminating trade deficits, then there will be less overseas funding of US government bond issuance,” Riddell warns.

In short, America’s ability to finance its own economic strategy could be under threat.

In the short term, markets will continue to grapple with headline risk, volatility and uncertainty.

“The downside risks to economic growth and corporate earnings are clear,” says Willis.

“Irrespective of the tariff polices themselves, the persistent uncertainty alone will detract from economic growth, given the hiatus in spending and investment decisions that it will cause,” he adds.

Even recent data from China, which shows surprisingly strong first-quarter growth of 5.4% year-on-year, may not offer much relief.

“This raises a question over distortions in the data from China and elsewhere as companies and consumers try to get ahead of the tariffs, leaving a potential ‘air pocket’ ahead when demand slows as tariffs take effect,” Willis says.

For now, the world watches and waits. The rules of engagement have changed – and investors may have to rethink the very foundation of what constitutes a “safe haven.”