Foreign Buyers Retreat from US Debt Amid Mounting Fiscal Risks

Foreign Buyers Retreat from US Debt Amid Mounting Fiscal Risks 

Yesterday's discussions centered around the underwhelming outcome of a major Treasury bond auction. Specifically, it involved a $15 billion sale of 20-year U.S. government bonds. While the results were not as disastrous as some critics claimed, the auction did reflect the largest yield premium of the year, signaling less investor enthusiasm than desired. This development drew immediate comparisons to Japan's own struggles earlier in the year with a similar bond sale, which triggered significant volatility across financial markets. Stocks and bonds both suffered in the aftermath of that Japanese auction, and now a similar scenario seems to be unfolding in the United States.

The broader implication of the market's negative reaction isn't just about one auction. It's part of a much larger and growing concern over the country's fiscal path. The United States continues to accumulate massive amounts of debt, with projections suggesting another five trillion dollars will be added on top of already ballooning obligations. Market participants, particularly those often dubbed "bond vigilantes" — investors who demand higher yields in response to rising debt or inflation — appear to be reawakening after years of dormancy. That long period of calm was largely maintained through central bank interventions like quantitative easing and, more recently, ideas like Treasury buybacks aimed at calming market nerves.

More troubling than the selloff, however, was the weakening of the U.S. dollar that accompanied it. Normally, higher yields on government bonds attract foreign investment and support the currency. This time, however, the opposite happened. The decline in the dollar's value alongside the auction's poor performance suggested a deeper unease. George Saravelos, a senior strategist focusing on currency markets, pointed to the growing divergence between U.S. bond yields and the value of the yen as a red flag. He believes this gap reflects a lack of interest from foreign investors, especially in U.S. assets, and highlights growing global concerns about America's fiscal trajectory.

The underlying issue, according to Saravelos, is that the rest of the world—particularly countries in Asia—is losing appetite for financing the massive deficits the U.S. continues to run. Foreign investors have traditionally played a key role in supporting U.S. borrowing needs, especially by purchasing long-term Treasuries. But in recent years, and especially in recent weeks, there has been a noticeable shift. Investors from abroad are increasingly reluctant to buy American debt at current yields, likely because they do not see the returns as compensating for the risks.

This matters for several reasons. One, it's difficult for U.S. stock markets to maintain strength if foreign money is not flowing into the country to support both equities and debt markets. In previous years, rising interest rates and higher equity prices moved in tandem, supported by robust economic growth expectations. But now the backdrop is different. Rising interest rates are being driven more by fears of government overreach and growing fiscal deficits than by optimism about future growth. This adds a new layer of risk to markets.

Saravelos highlights the role of Asian investors in particular. Under his economic framework, these investors have been the backbone of support for U.S. deficits. When their enthusiasm wanes, especially during trading hours in their own markets, the impact becomes evident in falling bond prices and a weakening dollar. He noted that if the yen strengthens sharply during Japanese trading hours while U.S. bonds are selling off, it's a clear sign of capital flowing out of the U.S. and back into home markets.

Reversing this trend won't be easy. Saravelos reported that he's had multiple conversations with clients about how to stop the slide in sentiment. But the most commonly suggested fixes are far from painless. One idea is to change the structure of U.S. debt issuance — favoring shorter maturities which carry less duration risk and might appeal more to jittery investors. This could help, but it also increases the frequency with which debt must be rolled over, heightening vulnerability if market conditions deteriorate.

Another often-discussed option involves loosening bank regulations to allow them to buy more government debt, essentially a backdoor form of financial repression. While this might shore up demand in the short term, it also distorts markets and can create longer-term problems. Then there's the possibility of the Federal Reserve stepping in with emergency measures, such as resuming large-scale bond purchases. This, too, is a short-term fix that risks sparking higher inflation and undermining confidence further.

In Saravelos' view, only significant changes to fiscal policy can truly fix the problem. He outlines two stark paths forward. The first involves a dramatic revision of existing government spending plans — particularly cutting back a massive bill currently before Congress that would add trillions to the national debt. Doing so would almost certainly plunge the economy into recession or worse, but it might restore some credibility to fiscal policy. The second path involves a significant weakening of the dollar, which would make U.S. debt cheaper and potentially attractive again to foreign investors. But this would come at the cost of higher import prices and possibly rising inflation at home.

Both options are politically and economically fraught. The first is unlikely, especially with election cycles and entrenched political opposition. The second is more likely to happen by default rather than design. Yet Saravelos offers additional alternatives that may come into play. One involves the reintroduction of yield curve control — an approach where the government explicitly targets bond yields — similar to what was done during and after World War II. This would be a bold move, but one he sees as increasingly likely.

He also foresees a greater role for the U.S. Treasury itself in stabilizing markets. With current buyback programs relatively small, he expects a shift toward more aggressive intervention, potentially involving tens of billions of dollars in Treasury repurchases. This would represent a new phase of direct market involvement, aiming to support bond prices and maintain orderly conditions.

An unresolved question in all of this is where the capital that used to buy U.S. debt is now going. If Japanese investors, for example, are no longer keen on long-dated U.S. or even domestic bonds, what assets are absorbing their capital? The shift in global investment flows remains an important and open issue, with implications for markets well beyond the United States. The answers to these questions will shape how global finance evolves in the face of rising debt and changing geopolitical priorities.