Choosing safe assets during a financial crisis: Are U.S. Treasury bonds really safe?

As economic uncertainty increases, investors seek safe havens to protect their assets. Among them, U.S. Treasury Bonds are regarded as the flagship safe asset globally, based on the trust that “as long as the U.S. government doesn’t go bankrupt, the principal is safe.” However, even known safe investment instruments carry their own risks. Especially from a Korean investor’s perspective, one must consider U.S. Treasury yield fluctuations, exchange rate movements, and inflation. This article examines the realistic risks and returns of U.S. Treasury investments and explores optimal combinations with Korean portfolios.

Basic Concepts for Understanding Bond Investments

Bonds are essentially IOUs. Governments or corporations borrow funds from investors, promise to return the principal(face value) at maturity, and pay interest during the process. When the U.S. government needs funds for national operations and tax revenue falls short, it issues bonds, which are purchased by investors who receive regular interest payments, typically semi-annually(.

The most actively traded product in the bond market is the U.S. 10-year Treasury note. These 10-year bonds are mainly traded for investment purposes rather than holding to maturity, and they serve as the most sensitive indicator reflecting market economic sentiment. In fact, the U.S. Treasury yield acts as a benchmark for global financial markets. Bank lending rates, mortgage rates, and corporate bond yields are all determined based on the interest rate of the U.S. 10-year Treasury.

Types and Yield Structures of U.S. Treasuries

U.S. Treasury securities are issued in three main types based on maturity:

T-bill)Short-term Treasury(: Maturity under 1 year, minimal risk, high liquidity
T-note)Medium-term Treasury(: Maturity 1–10 years, moderate yields
T-Bond)Long-term Treasury(: Maturity 10–30 years, fixed interest rate providing long-term returns

Generally, longer maturities require higher interest rates on the normal yield curve. However, during economic crises, demand for long-term bonds surges, causing long-term yields to fall below short-term yields, resulting in an inverted yield curve. This phenomenon is considered a recession indicator.

Yield)Yield( refers to the expected return relative to the purchase price of the bond. The issuance price and the market price differ. When demand for Treasuries increases, prices rise and interest rates fall; when demand decreases, prices fall and interest rates rise. In short, bond prices and interest rates move inversely.

Practical Advantages of Investing in U.S. Treasuries

@E0# 1. Government Guarantee and Creditworthiness
Since the U.S. government guarantees repayment, the risk of default is extremely low. During recessions, many investors flock to this product.

@E0# 2. Predictable Regular Income
The fixed interest rate at issuance remains until maturity, with interest typically paid semi-annually. Ideal for investors needing steady income, such as retirees.

@E0# 3. Excellent Market Liquidity
As the most actively traded bond, it can be quickly liquidated if needed. Selling before maturity is also straightforward.

@E0# 4. Tax Benefits
Interest is subject to federal taxes but exempt from state and local taxes, potentially increasing after-tax returns.

Hidden Risks in U.S. Treasury Investments

@E0# 1. Interest Rate Risk
If U.S. Treasury yields rise after purchase, new bonds are issued at higher interest rates. Existing bonds become less attractive and their prices decline. Selling before maturity may result in losses.

@E0# 2. Inflation Erosion
Since fixed interest rates are provided, if inflation exceeds the yield, real returns decrease. The longer inflation persists above the yield, the greater the loss of purchasing power.

@E0# 3. Exchange Rate Risk)Essential for Korean Investors###
If the Korean won weakens against the dollar, both interest and principal converted to won can result in losses. Conversely, a strong dollar can generate currency gains.

@E0# 4. Credit Risk###Minimal but Present###
While the likelihood of U.S. government default is extremely low, it is theoretically possible. In extreme political or economic crises, credit ratings could be downgraded.

Three Methods to Invest in U.S. Treasuries

@E0# Method 1: Direct Purchase
Buy directly from the U.S. Treasury via the TreasuryDirect website or through securities firms in the secondary market.

Advantages: Full control over individual bonds, no commission fees, regular interest payments, and principal repayment at maturity.

Disadvantages: Maximum purchase limit of $10,000 per transaction, requires significant capital and management for diversification, potential losses if interest rates rise and bonds are sold early.

Suitable for: Conservative investors seeking stable income with long-term holding, retirees.

@E0# Method 2: Bond Mutual Funds
Pool funds from multiple investors managed by professional managers who operate diversified bond portfolios.

Advantages: Diversification reduces risk of individual bonds, professional management, accessible with small amounts.

Disadvantages: Management fees reduce returns, no direct control over individual bonds.

Suitable for: Investors who prefer professional management and diversification.

@E0# Method 3: Bond Index Funds###ETFs(
Exchange-traded funds that track specific bond indices, traded on stock exchanges like stocks.

Advantages: Passive management with low fees, flexible trading, high liquidity, transparent index tracking.

Disadvantages: Price volatility due to market fluctuations, no excess returns from active management, tracking errors.

Suitable for: Investors seeking low-cost, passive exposure to Treasuries.

Optimal Strategies for Korean Investors’ Bond Portfolios

@E0# Strategy 1: Geographic Diversification to Reduce Risk
Construct a balanced portfolio with 50% Korean bonds and 50% U.S. Treasuries to mitigate country-specific risks. Economic downturns in one country may be offset by growth in the other.

@E0# Strategy 2: Currency Hedging to Manage Exchange Rate Risk
To prevent losses during a weakening dollar, some portion of U.S. Treasury holdings can be hedged via forward contracts. During a strong dollar phase, unhedged portions can yield high won-based returns. Partial hedging)e.g., 50% of U.S. Treasuries###strikes a balance between exchange rate risk and potential gains.

@E0# Strategy 3: Duration Matching
Duration measures a bond’s sensitivity to interest rate changes. For principal preservation, focus on longer-maturity U.S. Treasuries; to reduce interest rate volatility, mix in shorter-term bonds.

@E0# Strategy 4: Tax Optimization
Interest from U.S. Treasuries is subject to U.S. federal tax but also taxed in Korea. The U.S.-Korea Double Taxation Agreement###DTA### allows for efficient tax planning with professional advice.

Practical Example: Portfolio Performance in a Strong Dollar Phase

Consider a balanced portfolio of 50% Korean bonds and 50% U.S. Treasuries. During a recent strong dollar period, the unhedged portion of U.S. Treasuries yields higher returns in won terms due to currency gains. The hedged portion offsets currency losses, providing stability. This approach manages both risk and return simultaneously.

Conclusion

U.S. Treasuries are undoubtedly the flagship safe asset, but they are not entirely risk-free. Fluctuations in U.S. Treasury yields, inflation, exchange rates, and even credit risk can impact actual returns. For Korean investors, exchange rate risk and tax considerations are especially important.

Whether through direct purchase, funds, or ETFs, understanding your investment goals and risk tolerance is crucial. Combining U.S. Treasuries with Korean bonds, employing currency hedging, and duration strategies can help balance stability and profitability.