Jamie Dimon, CEO of JPMorgan Chase, recently said he wouldn’t buy long-term U.S. Treasuries. His rationale is simple, he “doesn’t understand the upside.”
Here at the Economic Prism, we don’t understand the upside either. But, unlike Dimon, we’re not running the largest primary dealer of U.S. Treasuries on Earth.
Primary dealers, remember, are the elite financial institutions obligated to participate in U.S. Treasury auctions. Their purpose is to help grease the wheels of Uncle Sam’s multi-trillion-dollar borrowing machine. Yet Dimon, the chief architect of that machine’s biggest partner, just publicly bashed the product.
So, what does Dimon actually mean? Why would the ultimate financial insider pass on what has long been purported to be the world’s safest asset?
To understand why Dimon “doesn’t see the upside,” we need to start with the single most fundamental rule of fixed income. When yields go up, bond prices go down.
Imagine you buy a 10-year U.S. Treasury bond today with a face value of $1,000 paying a fixed 4.5 percent annual interest rate. You’re locked into receiving $45 a year for the next decade.
Now, assume that next year, due to sticky inflation or massive government borrowing, new 10-year Treasuries are issued paying 5.5 percent – or $55 a year.
If you decide to sell your 4.5 percent bond before it matures, who is going to pay you $1,000 for a paper that pays $45 when they can walk down the street and get a fresh paper paying $55?
Nobody.
To make your older bond attractive to a buyer, you have to discount its price below $1,000. The farther yields rise, the deeper your bond’s price falls in the secondary market.
When Jamie Dimon says he sees no upside in holding long-dated U.S. Treasuries at current yield levels around 4.5 percent, he is making a clear bet that yields are going higher, which means long-term bond prices are heading lower.
A World of Rising Yields
U.S. government spending is completely out of control. Uncle Sam’s running trillion-dollar deficits year after year. What’s more, these deficits are not countercyclical. They’ve been happening during economic expansions.
To cover the gap, the Treasury must flood the market with massive amounts of new bonds. Naturally, when supply overwhelms demand, prices fall and yields must rise to entice buyers.
So, too, central banks and foreign governments can no longer be counted on to buy up U.S. government debt as a matter or routine. Many central banks are currently reducing their holdings of treasuries. At the same time, institutional investors are demanding higher yields to compensate for holding long-term U.S. fiscal risk.
Ongoing wars, supply chain disruptions and realignments, massive data center investments, and expanding defense spending mean inflation won’t quietly disappear. Thus, central banks, including the Federal Reserve, will be compelled to keep interest rates higher for longer.
This combination of endless supply, diminishing foreign purchases, and sticky inflation leaves Washington facing a fiscal reckoning. As older debt issued during the low-rate era matures, the U.S. government is forced to refinance it at drastically higher rates.
Annual net interest payments on the national debt have already surged past the entire defense budget. This creates a compounding feedback loop where the government must borrow simply to pay the interest on what it previously borrowed.
Ultimately, higher long-term yields will impact the economy. In short, higher borrowing costs weigh down economic activity. For example, they force mortgage rates upward. Higher interest rates also drastically increase capital costs for businesses.
When borrowing costs rise, every asset class must adjust, squeezing corporate profit margins and tightening financial conditions across the board.
Higher Yields Ripple Across the Land
When long-term Treasury yields remain high or trend upward, the entire financial system gets squeezed. Treasury yields act as the foundational risk-free rate from which almost every other asset in the world is priced.
Mortgage rates, for example, do not directly mirror the Federal Reserve’s short-term benchmark rate. They generally track the 10-year U.S. Treasury yield. When 10-year yields stay elevated above 4.5 percent, 30-year fixed mortgage rates remain anchored in the 6.5 to 7 percent range. This creates a double whammy for housing.
Existing homeowners with 3 percent mortgages from 2020–2021 refuse to sell, keeping inventory historically tight. At the same time, first-time buyers face record-high housing prices combined with elevated borrowing costs, pricing millions out of the market. Housing developers also face higher construction financing costs, which reduces new home supply.
During the prior decade of near-zero interest rates, corporations gorged on cheap debt. Millions of companies issued corporate bonds or took out loans at dirt-cheap rates. As these loans mature, businesses are having to replace 3 percent corporate debt with 7 or 8 percent corporate debt.
Higher debt servicing eats directly into corporate profits, forcing cost-cutting measures or price hikes. This also compels companies to scale back expansion, equipment upgrades, and research and development, because borrowing to fund growth no longer makes financial sense.
Eventually, the zombie companies – businesses that barely make enough revenue to service their debt – are forced into bankruptcy.
Higher yields also exert downward pressure on the stock market. Valuations, which rely on discounting future cash flows back to present value using the risk-free rate, compress. When the discount rate goes up, the present value of future earnings goes down. High price-to-earnings (P/E) ratios become harder to justify.
Also, when risk-free Treasuries pay 5 percent, cash and short-term bonds offer a legitimate alternative to volatile stocks. Investors no longer feel forced to buy equities just to beat 0 percent interest rates.
Brace for Volatility
Perhaps the most important consequence of Dimon’s warning is what it means for the U.S. government’s own balance sheet. The U.S. national debt is racing towards $40 trillion. As older, low-interest government debt matures, the Treasury must issue new debt at much higher current interest rates.
As noted above, annual interest payments on the national debt have already surpassed the entire U.S. defense budget. What will happen when the yield on the 10-year Treasury spikes above 8 percent?
Another consequence is that as interest payments take up a larger slice of the federal budget, less money remains for infrastructure, defense, social programs, or tax cuts. Higher interest expenses require even more borrowing to cover the deficit, which increases bond supply, which pushes yields higher, thus creating a dangerous fiscal feedback loop.
Dimon’s refusal to buy long-term Treasuries offers a lesson in risk management. If the chief banker of Wall Street is worried about long-term duration risk, perhaps individual investors should too.
By this, don’t count your chickens before they hatch. Holding short-term Treasuries or cash equivalents, as opposed to long-term Treasuries, allows you to capture high yields without locking yourself into long-term price risk.
With respect to stocks, in an era of higher borrowing costs, companies with strong balance sheets, minimal debt, and robust free cash flow will outperform heavily indebted firms. But regardless, as fiscal pressures mount on Uncle Sam, interest rate swings and stock market pullbacks are likely to become more frequent. Expect greater volatility in the months ahead.
When Dimon says he doesn’t understand the upside of long-term Treasuries, he is telling us that the rules of the investment game have changed. The era of easy money, cheap government debt, and risk-free bond gains is in the rearview mirror.
Adapting to this higher-yield reality isn’t optional. It’s essential.
[Editor’s note: Get a free copy of an important special report called, “Fission for Millions – The Ultimate Bet on the AI Energy Crisis,” when you join the Economic Prism mailing list today. If you want a special trial deal to check out MN Gordon’s Wealth Prism Letter, you can grab that here.]
Sincerely,
MN Gordon
for Economic Prism
