Executive Summary
With Treasury yield spreads compressed versus German Bunds and U.K. Gilts, term premium near historical lows, and inflation expectations firming, questions remain whether markets are embedding enough sovereign or geopolitical risk in Treasuries.
From Risk‑Free to Political Instrument
For decades, U.S. Treasuries functioned as the world’s de facto risk‑free asset: deep, dollar‑denominated and as close to a zero‑default instrument as markets could find. Even today, the 10‑year note trades around 4.10%–4.20%, and the probability of outright non‑payment remains extremely low. What has changed is the tail: in an era of sanctions, reserve freezes and more explicit weaponization of financial channels, investors can no longer honestly assign a literal zero to the chance that some holders might not be repaid in full and on time under every geopolitical scenario. The conceptual shift from “impossible” to “highly unlikely” should, in theory, command a non‑zero risk premium.
Spreads to Bunds, Gilts Historically Thin
Yet the cross‑market data shows little evidence of that premium. The U.S. 10‑year yield, at roughly 4.1%–4.2%, sits only about 1.3 percentage points above the German 10‑year Bund, which is near 2.8%—toward the lower end of the 150–250 basis point range that has prevailed for much of the past decade. Against the UK, the picture is even starker: the 10‑year Gilt is yielding around 4.5%–4.6%, roughly 30–40 basis points above Treasuries, so the traditional U.S. pickup over Gilts has flipped into a modest discount.
Historically, higher U.S. potential growth and structurally looser fiscal policy justified a consistent positive spread to both Bunds and Gilts; today, relative policy expectations and inflation differentials can almost fully explain the current gaps, leaving no obvious “leftover” that looks like compensation for U.S.‑specific political or sanctions risk.
FX vs Yields
The main pushback is that any extra risk for foreign holders should materialize in FX, not yields. If reserve managers or sovereign funds judged Treasuries too politically risky, they would sell; domestic investors would step in at yields anchored by Fed policy and inflation expectations, while the dollar would absorb the shock via depreciation. In that stylized view, the Treasury curve remains a clean function of expected short rates and inflation, and geopolitical risk is priced in the currency.
The problem is that this logic relies on a bright line between foreign and domestic investors that the last decade’s policy experimentation has already blurred. Once you accept that specific holder groups can be targeted in one episode, it becomes harder to argue domestic institutions could never face analogous constraints in a future crisis. Even a perceived 1–2% tail where principal, liquidity or payment mechanics might be impaired for some U.S.‑based holders should, in standard term‑structure models, push term premia, and thus long‑end yields, above levels implied by economics alone.
Inflation Expectations Under Trump as the Bigger Catalyst
On top of the structural/geopolitical question sits a more immediate macro risk: the Trump administration’s policy mix. Ten‑year nominal yields around 4.1% against 10‑year TIPS yields near 1.8% imply breakeven inflation of roughly 2.3%–2.4%, only slightly above the Fed’s target and below the peaks seen earlier in this cycle.
Yet tariff announcements and talk of broader import levies have already prompted analysts to pencil in a renewed drift higher in U.S. inflation, with some forecasts warning that headline CPI could re‑approach or exceed 3% if tariff pass‑through and wage pressure persist throughout 2026. If inflation expectations move even 50–75 basis points higher while real yields stay near current levels, fair‑value 10‑year Treasuries would be closer to 4.6%–5.0%—well above where they trade today.
Mispricing Waiting to Be Corrected
The quantitative picture is awkward for anyone still treating Treasuries as the unquestioned risk‑free benchmark. The 10‑year trades only about 130 basis points over Bunds and at a discount to Gilts; breakeven inflation prices a benign mid‑2s path; and there is no obvious residual spread that looks like compensation for non‑zero geopolitical tail risk.
In a world of weaponized finance and tariff‑driven inflation, that combination suggests not just a theoretical debate about “risk‑free,” but a concrete mispricing that could be resolved by higher U.S. yields, weaker Treasuries, or both.
More Treasury & Rates columns
- Markets May Need to Confront a 3% Inflation Reality
- Warsh Nomination Signals Potential Regime Shift, New Curve Playbook
- Trump’s $200B MBS Push Sets Up Volatility, Not Lasting Affordability
- Japan’s Bond Shock Is a Quiet Headwind for Lower U.S. Rates
- Hidden Leverage: Why the Treasury Market’s Quiet Stability May Be Deceptive
- Duration Divergence: Bond Markets Signal Disbelief in the Fed’s Inflation Narrative
- Floating Rates, Firm Reserves: How the Fed Is Quietly Resetting the Front End
- Rate Volatility Looks Mismatched to the Fed and Macro Risks Ahead
- Bond Return Forecasting Enters New Era of Complexity
- Bond Market’s “Soft Landing” Trade Looks Stretched as Long-End Yields Defy Inflation Math
The post U.S. Treasuries Still “Safe” But No Longer Truly Risk-Free appeared first on Connect CRE.