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Not All US Treasuries Are ‘Truly Safe,’ Dallas Fed Paper Says

(Bloomberg) -- US Treasuries are seen globally as the world’s favored haven asset. Yet it’s short maturities that best fit that definition, according to a Federal Reserve Bank of Dallas paper.

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“Not all Treasury securities are equally safe,” according to the paper published Tuesday by economist J. Scott Davis. “Long-term Treasury bonds may have no default risk, but they have liquidity risk and interest-rate risk — when selling the bond prior to maturity, the sales price is sometimes uncertain, especially in times financial market stress.”

“Short-term US safe assets are the assets that are truly safe, and safe haven flows lead to an increase in these short-term inflows, even while long-term inflows fall,” Davis concluded.

These risks were underscored in March amid the US regional banking crisis, when losses on long-term Treasuries and other government-related debt became key forces that brought down several regional banks. There was of course a run on deposits, yet clients’ realization that banks were sitting on large unrealized losses on long-term government debt helped spark the tumult.

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The US has a large external debt, particularly in safe assets, Davis writes. In times of crisis, investors view US debt - especially short-term Treasuries — as a harbor.

“In a crisis, when investors prize safety and liquidity, they flock to safe short-term T-bills,” Davis wrote. He laid out how in two recent major financial crises, from 2007 to 2009 and during the onset of the pandemic in 2020, “long-term US portfolio debt inflows fell but short-term portfolio debt inflows increased.”

Supporting US assets overall during these turbulent periods is the fact that the dollar is the world’s reserve currency, tending to appreciate during crises, the economist writes.

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