US regime shift leaves bonds with a licence to thrill

Longer-term Treasuries are increasingly acting like risk assets, shaking investor assumptions and changing widely accepted asset allocation conventions.

There was a time when the safest place for investors to hide was at the far end of the yield curve.

No matter the crisis, no matter the volatility in equity markets, long-term US Treasuries were the ballast — the part of the portfolio that investors never needed to worry about.

But that reflex is now under direct attack and the investment world is still reacting far too slowly.

The sharp selloff of 30-year US government bonds in May, which briefly sent yields surging above 5 per cent, is not just a technical wobble or a seasonal repricing. It is confirmation that one of the most trusted assumptions in modern portfolio theory is losing its grip.

Long bonds — the bedrock of traditional diversification — are behaving more like risk assets than stores of safety. This shift has major consequences for capital allocation, institutional strategy and retail portfolios alike.

Portfolio cushions

For decades, the logic behind the 60/40 portfolio was straightforward: when stocks fell, bonds rose. Their inverse relationship helped cushion portfolios during periods of market stress.

However, this comforting negative correlation has started to fray. During May, we watched a familiar pattern break down: stocks declined — and long Treasuries went right down with them.

This is not about inflation expectations or a surprise from the Fed. What’s driving this change is something deeper and more structural.

The US fiscal trajectory, with mounting deficits and massive Treasury issuance, is no longer a background worry. It is fast becoming a pricing force.

Investors are looking at the sheer scale of long-term US debt, the political gridlock in Washington, and the absence of any credible plan to contain either, and they are asking whether these bonds really deserve the label ‘risk-free’ at all.

They don’t. At least not in the way portfolios have come to rely on them.

Fantasy fund management

Long-duration Treasuries are extremely sensitive to shifts in sentiment, liquidity and issuance. In a world where the US is regularly auctioning hundreds of billions in new paper and buyers are becoming more selective, the idea that these bonds always rally when markets turn risk-off is fantasy.

This behavioural shift matters because it erodes one of the most common foundations of modern investing: that diversification can be achieved through exposure to uncorrelated assets. When bonds stop offering that hedge, portfolio construction gets far more complicated and the risks more concentrated than they appear.

The illusion of safety in long bonds is what makes them dangerous now. Not because they are toxic in themselves, but because they are misclassified in most portfolios. Investors are treating them as a volatility buffer. In reality, they’re becoming a source of it.

”The illusion of safety in long bonds is what makes them dangerous now”

What should serious investors do now then?

The first step is to discard outdated assumptions. Asset labels are no longer helpful shortcuts. Safe, risky, growth, defensive — these categories only matter if they correspond with how the asset actually behaves under stress. Right now, long Treasuries are trading more like speculative tech than sovereign defence.

That does not mean we should be abandoning bonds altogether. It means rethinking their purpose. Duration exposure should now be treated as a directional bet on US fiscal and monetary credibility. Not a hedge, nor an anchor. They have become a high-conviction trade.

Naturally, this requires a shift in mindset, especially among those using static models or relying on traditional rebalancing frameworks. Bonds can still play a critical role, but they must be used more precisely: shorter durations, higher credit quality and greater international exposure all need to be weighed more carefully.

Investors must also look more broadly at where protection is coming from. This might mean building exposure to assets that tend to benefit from fiscal instability — hard commodities, infrastructure debt, select emerging market sovereigns with healthier balance sheets.

Passive positioning

Perhaps most importantly, investors should be questioning the entire premise of passive positioning in fixed income.

Buying the index used to be safe. Now, it can embed risks that few realise they are carrying, especially when that index is heavily weighted toward longer-term debt issued in a country with deteriorating fiscal discipline.

It is no longer enough to rely on historical relationships or average returns. Correlations can turn, and when they do, they tend to do so when it hurts the most. What is needed now is proactive oversight and a redefinition of what diversification actually means in a world where traditional hedges no longer hedge.

This may feel uncomfortable. But it is also an opportunity, as well as a challenge. Those who reassess their exposure now, who stop treating long bonds as untouchable, will be better placed to manage through this apparent regime shift.

Nigel Green, deVere Group CEO and founder