Here's Why America's Debt is a Trade War Victim
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I'm Stephen Carroll and this is Here's Why, where we take one news story and explain it in just a few minutes with our experts here at Bloomberg.

The bond market is very tricky. I was watching it, but if you look at it now, it's beautiful. The bond market right now is beautiful. But yeah, I saw last night where people were getting a little queasy. Donald Trump's trade tariffs have investors on edge. The wild swings in prices of U.S. government debt and the volatility in borrowing costs that comes with it

have been the most glaring example of a loss of confidence in what's long been considered a safe investment. Foreign investors hold trillions of dollars in treasuries. So what happens if they decide to put their money elsewhere? "Japan and China are two of the largest holders of US treasuries and if they decide

but they don't want to show up at an auction. It's going to be very tricky. I think what the treasury market is telling us is that there is not a lot of balance sheet availability to absorb all this treasury selling. 2025 feels like a US-driven situation and a willingness on the part of foreign investors to liquidate dollar assets. Treasuries are part of that complex. Here's why America's debt is a trade war victim.

Our managing editor for FX and Rates, Rachel Evans, joins me now for more. Rachel, first of all, how important are foreign buyers for US government borrowing? Very important. They comprise about a third of ownership for the treasury market. So it's a significant piece of the pie. And there's some analysis out there from Barclays that's interesting that suggests that last year, sort of foreign buyers were really taking down like a large chunk of the debt issuance that the US was putting out there.

These are all different types of owners. You've got pension funds, you've got insurers, and you've also got central banks that are sticking these into their reserves, theoretically, as kind of a pillar of stability for themselves. The term buyer strike might sound

quite incendiary in a lot of ways. But what would a buyer's strike look like in the US Treasury market? Yeah, I think simply put, and we haven't really seen this necessarily, so it's kind of hard to exactly what it would look like. But simply put, you would see yields continually rising day after day, and particularly at the long end. When we look at kind of the division of the types of Treasuries that are owned by foreign buyers, it's

it tends to skew towards longer-dated debt, so 30-year debt. So, if you're starting to see yields really kind of rocketing up at the long end in 30-year debt, borrowing costs really soaring there day after day after day, that would be an indication that you're starting to see foreign buyers pulling back.

And so far, no sign of that that we've seen in markets. We've seen little dribs and drabs, but we haven't kind of seen the sort of the prolonged action that you would necessarily sort of view as being kind of a buyer strike. We had a slightly iffy auction earlier in the week where we saw three-year debt sort of struggling to find as much demand as it might sometimes. And we've seen steeper yield curves. So the back end of the curve selling off more, those yields on 30-year debt rising more. So that does indicate sort of

the potential for demand overall is kind of diminishing a little bit. And I was also taken by some analysis that our colleague Cameron Christ did that suggested that since Trump's inauguration, we've actually seen most selling outside of US hours. So that tells you that in terms of who is doing the selling that it is often coming from overseas. So there's been

these kind of little hints of unease, I think, amongst kind of foreign investors, but we've not seen kind of the action that would suggest sort of a bona fide buyer strike that's really going to be there for the longer term. So a determined sort of pullback that we would term a strike in this context. I mean, if it were to happen, theoretically, what would a loss of foreign interest in US debt mean for the US government?

I mean, very simply, higher yields. So higher borrowing costs for the US government. They would need to pay more to refinance their debt and to borrow new money. That would also have a ripple-through effect to things like mortgage rates, which track 10-year yields and therefore would also be going up. So you'd be getting kind of that ripple-through effect

from the US's borrowing costs through to sort of the average American's borrowing costs and their debt load. You'd also potentially see the US government have to rethink how it sells debt. At the moment, you know, you have kind of a balance between sort of short dated bonds and longer dated securities that's kind of set by Treasury to sort of tap into investor interest. Now, Scott Besson has said that he would like to move away from having so much

debt at the short end of the curve. So many bills, he wants more longer term debt. However, if your cost of longer term debt is skyrocketing upwards, that becomes very, very difficult and the need to really issue more short dated debt that you can pay less on becomes higher. So I think you sort of have to see that the government recalibrating how it sells debt in order to make sure that it's tapping the investors that do stick around.

And would the Federal Reserve get involved in this? Would there be a moment at which something would get so dramatic that the central bank would have to act? So the central bank has its obviously economic mandate where it's thinking about inflation and growth and jobs. So this doesn't necessarily impinge on that. They're also looking at kind of market functioning. So I think where the Fed might get involved is if you see some dislocations and some breakages in how the market functions.

Something extremely abnormal, essentially. Exactly. I mean, this is sort of what we saw back in like March 2020, when we saw kind of a huge liquidation of pretty much every assets, but a dash for cash. And that really kind of sort of broke some of the plumbing in the markets. We saw a lot of hedge fund trades unwinding very, very rapidly. And the Fed did step in then with various kind of facilities to try and kind of

ease some of the liquidity constraints that were really sort of upsetting the market at the time. So there has been some sort of conversation in markets about whether the Fed could intervene or how they'd intervene. Some speculate that maybe they could step in and do sort of an emergency QE, stepping in to buy bonds. Others say, no, that's not likely, but maybe we could see sort of exemptions from the so-called supplementary leverage ratio. So the SLR kind of restricts how much

dealers can have on their balance sheet in terms of treasuries. If you suspended that, people might have a little bit more room to kind of manage a rapid sell-off. So there's kind of conversations about that, but we haven't got to a point yet where those dislocations are particularly severe. In fact, looking kind of at funding markets, while we are seeing sort of an increase in cost, it's still relatively contained. And I think Beth Hammock of the Cleveland Fed sort of described them as strained, but sort of working.

Okay, so question marks over that safe haven status rather than necessarily a serious attack on it? Yeah, I mean, I think we will see. I mean, we are seeing kind of like rallies in European bonds this week. They're providing kind of an alternative to those who are seeking havens. I think there's a lot of bigger questions, just kind of given this very volatile period we've had since the tariff announcement, to what degree investors overseas continue to view treasuries as

or as a kind of stable asset that they want to hold as a haven. Obviously, the U.S. is still deeply embedded in the financial system. It's still a very kind of dollar-dominated financial system. So that's not going to change overnight. But, you know, you do sort of see kind of subtle shifts happening

happening over years. And I mean, a lot of people have talked about whether China could, for example, get out of its treasury holdings. And there's no indication of that happening immediately, but they have been reducing those gradually over the last decade. Because as we see trade tensions with China ramping up,

Is this actually something that could be a conscious decision that might come from Beijing, which would go beyond just investors looking elsewhere for more stable investments, but perhaps actually a tool in the trade war? Yeah, I mean, it's a good question to ask. And I think, you know, a lot of people are wondering, given we're in pretty unprecedented times, whether unprecedented trade war tools could be

be deployed. I mean, the Chinese government tends to take a more long-term picture about these things. I mean, as I mentioned, they've been kind of winding down some of their treasuries holdings over the last decade. They were at one point holding, I think, $1.3 trillion of US debt. That's now down to about $700 billion.

billion. And in fact, Japan is now the largest holder overseas of treasuries. So China doesn't necessarily have to move kind of immediately and like particularly with great speed. They have a very long term view on how to kind of change their policy. But it's certainly a kind of underlying concern that they could start dumping treasuries. At the moment, though, it seems more likely that they're going to manage the currency exchange rate as kind of their tool as a bit of a release valve for some of the

pressures that have been building up in relation to tariffs. Okay, Rachel Evans, our Managing Editor for FX and Rates, thank you. For more explanations like this from our team of 3000 journalists and analysts around the world, go to bloomberg.com slash explainers. I'm Stephen Carroll. This is Here's Why. I'll be back next week with more. Thanks for listening.

So

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