This is a sponsored article from Wellington Management.

Portfolio manager Connor Fitzgerald profiles the downside risks facing US growth, and the case for US Treasuries in fixed income portfolios against the current market backdrop.

We tend to view fixed income markets as a constantly evolving, probability-weighted, expected-value equation. Simply put, this means seeing a good result (outcome A) and a bad result (outcome B). I believe trying to predict the right future outcome and position your portfolio accordingly is futile.

Rather, I find more value in identifying a crowded trade – where the probability of outcome A is perceived to be much higher than the probability of outcome B – and analysing why outcome B may be more likely than market consensus and pricing imply.

Today, I believe the market is pricing the likelihood that the Trump administration’s policies will support US growth and lengthen the economic/credit cycles as outcome A. Outcome B – in which Trump’s policies negatively shock growth and tighten financial conditions in the US – may be more probable than the market expects.

Why? The stimulus measures it wants require Congressional approval and are not guaranteed. Today’s federal deficit and the fiscal stimulus pushed into the economy since the pandemic are unprecedented, with current spending relative to GDP historically seen only during crises, when growth was cratering.

I sense that the administration understands that the bond market may govern the amount of stimulus it can add. Further fiscal profligacy will likely come at a cost, through the level of bond yields. Contrary to the market’s reactions during the past five years of rising fiscal deficits, we may have reached the upper limit of how much fiscal stimulus the government can provide.

If that’s correct, then the only direction for stimulus to go from here is down. And if the government starts cutting spending, I believe the likelihood of a US recession goes way up and could lead to the reduction of US Treasury issuance.

Role of US Treasuries

While there is no shortage of higher-yielding and complex instruments available across fixed income markets, we believe US Treasuries constitute a critical component of a fixed income portfolio for structural reasons. Due to their stability relative to other fixed income instruments, US Treasuries can serve as both a hedge against credit exposure and an effective source of liquidity. This may be especially useful in times of volatility when they trade more easily than credit instruments.

During such times, market participants tend to flock to safe-haven assets and the demand for US Treasuries tends to spike. This said, we believe the time to consider Treasuries is before volatility strikes. If fixed income portfolios already hold US Treasuries when negative market events occur, investors may be able to dynamically rotate their allocations and beat the rush out of credit into Treasuries and transact at potentially more attractive levels on both sides of the trade.

Why now?

With many reasons to believe 2025 may be a volatile year, investors might want to consider the role of US Treasuries in their fixed income portfolios. The asset class represents the most abundant fixed income security in global bond markets, with more than US$19 trillion outstanding as of the end of 2024.¹

Regarding US Treasuries, duration is a key consideration. Compared to a year ago, market conditions have improved for Treasuries with five-to-ten-year duration. In our view, structurally, five-to-ten-year Treasuries offer a potentially compelling opportunity for risk-adjusted total return compared to both shorter and longer durations. With shorter durations, investors face the risk of underestimating price volatility. And longer durations involve more risk because they’re more sensitive to changes in interest rates and inflation expectations, for example.

In late 2023, policy rates were higher, and the yield curve was flatter. So, it was challenging to include US Treasuries in a fixed income portfolio because extending beyond short durations didn’t offer much benefit to investors.

But now, policy rates have come down, and those previously unattractive Treasuries with longer, five-to-ten-year durations, look more attractive. Due to our belief that Treasuries with these mid-range durations tend to have a more optimal balance of yield and duration, and market conditions are favourable now and in our near/mid-term outlook, we do not feel the need to extend duration further.

The bottom line

In our view, US Treasuries play an important role in fixed income portfolios because they’re more liquid than other types of fixed income, so they can potentially help hedge against credit risk and provide investors with dry powder to deploy when volatility creates attractive income and capital appreciation opportunities. Currently, market conditions are conducive to potentially attractive performance among five-to-ten-year Treasuries from a total return versus risk standpoint.

There’s a strong case to be made for the asset class, which investors may be able to access effectively through active management, rather than passive. If investors separate themselves from a benchmark, and adopt a total return approach that identifies upside potential beyond yield alone, they could be better positioned to rotate their allocations dynamically, shifting between Treasuries and other types of fixed income as needed, thus seeking to exploit price inefficiencies and generate income.

To read more insights from Connor Fitzgerald, visit Wellington Management’s website.
 

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¹“U.S. Treasury Monthly Statement of the Public Debt (MSPD),” FiscalData.Treasury.gov, 2025.

This is a sponsored article from Wellington Management.