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The world’s go-to safe haven asset, US government bonds are the cornerstone of the global financial system. But the $30tn Treasury market has shown new signs of strain due to shifting demand dynamics, large US deficits and shocks from unpredictable policymaking. Long-term yields have crept higher: the benchmark 10-year rate has largely been above 4 per cent in recent years, while last month a new issue of 30-year debt launched at a yield of 5 per cent for the first time since 2007. Treasury markets also appear more fragile, as seen in the bond market response to President Donald Trump’s “liberation day” tariffs in April of last year. Washington will need to address these risks if it is to avoid higher and more volatile borrowing costs.
Weaker demand for Treasuries is part of the story. In the early 2000s, central banks around the world, including those in export-led Asian economies, parked their considerable savings in ultra-safe Treasuries. Excess demand meant the US could finance its deficits while paying low interest rates. Former Federal Reserve chair Ben Bernanke called this phenomenon a “global savings glut.”
But in recent years, as the US has continued to issue debt and run large deficits, foreign central bank buying of Treasuries has not kept up. This shift was in part driven by economic factors, such as reserve drawdowns as China defended a declining renminbi, as well as strategic rationale: the looming threat of sanctions has encouraged Russia and China to diversify away from Treasuries and into assets such as gold. With fewer buyers chasing a growing pool of Treasuries, yields have crept higher in recent years. From a global savings glut, European Central Bank board member Isabel Schnabel has declared that we are transitioning to a “global bond glut”.
Another factor, as former Treasury official Geng Ngarmboonanant has pointed out, has been a change in Treasury buyers. Shorter-term investors such as hedge funds have flocked to US government bonds, more than doubling their presence in the past five years by purchasing a record share of the market. Unlike central banks and pension funds that must buy safe assets, funds are often more rate-sensitive buyers and can sell quickly in times of stress. Many of them finance trades by borrowing money to exploit small price discrepancies, adding more leverage to the Treasury market, which in turn amplifies volatility.
Changes to the plumbing of the Treasury market could relieve some of this pressure. The Securities and Exchange Commission adopted new rules for mandatory central clearing for Treasuries that could decrease counterparty risks, improve liquidity and possibly lower borrowing costs. Many banks argue that amending bank capital requirements adopted after the global financial crisis would allow banks to buy and hold more US debt. A growing stablecoin market might enhance demand for Treasuries, but if badly administered, could add new sources of strain.
The US Federal Reserve under its new chair Kevin Warsh could play a role remedying Treasury market fragility, for instance by developing emergency tools. That said, he has expressed a preference for quantitative tightening and less forward guidance, both of which could raise borrowing costs.
Though regulatory reforms would support confidence in the US government bond market, problems will persist as long as policymaking is capricious and the country continues to run large deficits. The surest way to counteract Treasury market instability is for the US government to proactively pursue greater fiscal responsibility and policy stability. If it does not, adverse market reactions could end up forcing its hand.
