It’s the biggest pile of debt in the world -- the $13.9 trillion U.S. Treasuries market. It’s been built with the help of foreign central banks and investors, who have clamored to buy U.S. government debt through good times and bad. But what happens if they lose their taste for Treasuries? With creditors from Tokyo to Beijing to London having second thoughts, we may be about to find out.
1. How do we know they’re having second thoughts?
They’re selling, a lot. Investors in Japan, the largest holder of Treasuries, culled their stakes in December by 2.39 trillion yen, the most in almost four years. China’s holdings dropped by the most on record during 2016. While the two countries still hold more than $1 trillion of debt each, this trend by America’s two biggest creditors has caught bond traders’ attention because it’s a departure from the buying binge of the recent past. Domestic investors likely picked up the slack, since benchmark 10-year yields climbed as much as 90 basis points from their lowest point on Election Night in November.
2. Why are they selling now?
In part for the same reason a wide range of investors elsewhere have been selling, too. There’s a broader market trend that’s been termed the "global reflation trade" in which bond traders have been driving up yields in the belief that stronger growth in the U.S. and Europe, plus President Donald Trump’s ambitious plans for debt-fueled spending, will put an end to a long period of low inflation and the low interest rates that accompanied it. In addition, with good alternatives at home, investors may be pulling back out of a desire not to get caught up in any geopolitical drama sparked by Trump’s aggressive talk about a tougher approach to trade.
3. Have foreigners ever held this much U.S. debt?
No. Nor has the U.S. ever owed so much. Foreign investors own $6 trillion in U.S. government debt, up from $3.08 trillion in 2008. (The share of debt owned by foreigners went down in that time period, to 43 percent from 56 percent, primarily because the Federal Reserve was buying so much itself.)
4. Why did their holdings grow so much?
Unconventional monetary policies from the European Central Bank and the Bank of Japan sent trillions of dollars of government bonds to sub-zero yields. That meant investors were essentially paying for the privilege of owning the debt. Many found that notion unbearable, so they flocked to the U.S., where yields remained positive, if still near all-time lows.
5. What’s the worry?
For investors, a selloff of bond holdings -- or even just a drop in bond purchases -- risks reducing the value of outstanding Treasuries, harming portfolios. For the U.S., which relies on bonds to finance government deficits, reduced demand means higher borrowing costs, squeezing the budget even more as spending on an aging population is projected to dramatically increase. For Trump, the headaches are both economic and political. His policy proposals include big tax cuts and increased spending on infrastructure and the military, which could translate to extra debt, which would be a lot less affordable if borrowing costs go up.
6. What’s the political problem for Trump?
Selling all that debt cheaply is going to require not just a domestic but a global buyer base. That need could collide with Trump’s plan for an aggressive campaign against what he calls unfair trading practices by other nations, most particularly China. Calling countries currency manipulators and threatening to erect big trade barriers isn’t a way to engender goodwill overseas. China could stop buying Treasuries or conceivably sell off much or even all of its giant reserves. That would leave permanent and long-lasting damage to the U.S. bond market.
7. Wouldn’t a big selloff hurt China, too?
Yes. But it would hurt in the sense of short-term losses on investments; the pain for the U.S. of higher interest costs would sting for years. Higher U.S. borrowing costs would also spill over into the private sector, where companies have embarked on major debt sales to cheaply finance their own growth. But there are reasons China is unlikely to dump a vast amount of its dollar holdings. China’s U.S. securities are how the nation deals with its large trade surplus. (American companies must sell dollars to China in order to buy yuan so they can buy and import Chinese goods into the U.S.) They’re also how China fixes its exchange rate to the dollar.
The Reference Shelf
- The Congressional Budget Office’s projections for growth in federal debt.
- An explanation of how Treasury auctions work.
- Treasury’s data on foreign holders of U.S. Treasuries.
- Titans of bond trading warned about fiscal stimulus even before Trump’s win.
- Bank of America sees demand for Treasuries shifting back to America in 2017.