The US government's efforts to roll back lockdown measures and re-open its economy amid an unprecedented pandemic have been dealt a grievous blow by nationwide anti-racism protests.

The mass movement threatens to send coronavirus cases soaring, cause the death toll to increase further from its current level of 107,000 and stifle any chance of an economic turnaround.

Despite this, institutional investors are unlikely to liquidate record volumes of US Treasuries as they did in March, when the initial outbreak of the pandemic and its spread in the US and Europe caused market panic.

Moreover, the renewed US-China tensions are not likely to threaten the status of US Treasuries as a safe haven asset for institutional investors and particularly life insurers, according to Tim Antonelli, Boston-based multi-asset insurance strategist at Wellington Management. The firm manages some $130 billion in insurance assets globally.  

While the relationship between the US and China will potentially remain strained, he argued that it would be in the current administration’s best interests to limit downside market volatility ahead of this year’s presidential election on November 3.

"We are likely on the doorstep of a global recession, so adding intelligently to credit will be critical for insurers to navigate a rising default cycle, not taking too much credit risk at this time is prudent," Antonelli told AsianInvestor..  

In April, the IMF projected the global economy would contract 3% this year, indicating the worst recession since the great depression in the 1930s, and far worse than the 2008 global financial crisis.

While low-interest rates have led some US-based life and health insurers to "meaningfully" reduce their exposure to US government bonds versus other fixed-income assets to achieve better returns, many of those in Asia would still opt for Treasuries, which they could barbell with riskier investments in their overseas allocations, said Antonelli.  

Tim Antonelli
Tim Antonelli

Insurance companies have been investing more in alternative assets to improve their returns. The companies contributed much more capital to unlisted real estate assets compared to five years ago, accounting for 26.7% of the total equity raised in 2019, versus 15.5% in 2015, according to Anrev, a real estate vehicle platform.

As insurers continue to ramp up their exposure to real estate and other alternatives, they are also required to hold government securities for regulatory reasons to ensure sufficient liquidity in times of stress in the market.

Another incentive to allocate to US Treasuries is the lower hedging costs associated with them. The costs of hedging some currencies have come down substantially over the past few months, allowing investors to take advantage of allocating to US Treasuries. 

In the case of the Singapore dollar, for instance, a three-year forward hedging contract cost is 0.03% as of May 29, down from 0.32% at the end of December. The yields on three-year US Treasuries stood at 0.19% on that day.

Furthermore, holding US Treasuries will only incur minimal capital costs for insurers. In the case of Singaporean insurance companies, bonds issued by central governments or central banks of countries or territories with a sovereign credit rating of A-minus or above are exempt from credit spread risk charges under the current risk-based capital II regime. US Treasuries are rated at AA+ by S&P, Aaa by Moody's and AAA by Fitch.  

STRUCTURAL ISSUES

While the immediate outlook for US Treasuries is stable, the Federal Reserve's whatever-it-takes approach to combat the economic impact of the Covid-19 outbreak could spell structural issues down the road for the country, potentially threatening the its credit rating.  

While affirming the US's economic strengths, Fitch said on March 26 that high fiscal deficits and debt, which were rising even before the virus, were starting to "erode these credit strengths".

“In the near term, is [the Fed’s stimulus package] positive? Yes, but in the medium term, is it that positive? That's a question mark to me because look at how much stimulus [the US] has been putting out, and we are talking about trillions of dollars that are being printed,” said Freddy Wong, head of Asia Pacific fixed income at Invesco. 

In addition to $3 trillion worth of government debt issuance, the Fed has announced an open-ended government bond-buying programme. The country’s GDP for the first quarter of this year posted a contraction of 4.8%, with its latest unemployment rate rising to 14.7%, a level last seen during the Great Depression era. 

President Donald Trump’s confrontational strategy towards China is also exacerbating economic stress.

“Tensions between the US and China have certainly heightened in recent months after already being on unstable ground before the Covid crisis, and in many ways, the global pandemic has expedited the trajectory the two global powers were already on,” said Antonelli.

It's also possible that the US will implement additional policy actions against China after the election.

Antonelli recommended that insurers look to quasi-government options that provide incremental yield versus regular government debt, such as agency mortgage-backed securities, to preserve strong liquidity characteristics. 

“US Treasuries remain the ultimate ‘risk-free’ asset in the capital markets, and I don’t expect that story to change, regardless of the debt situation that will evolve post-Covid,” he said. However, approximately 25% of the global government bonds market are currently offering negative yields, he added.