- Tepid demand for a 20-year bond auction sent Treasury yields spiking and the dollar tumbling this past week, amid mounting concerns over the federal government’s ability to continue financing massive deficits as Congress looks to add trillions of dollars more in red ink. For Deutsche Bank’s George Saravelos, they’re signs of a “buyer’s strike” among foreign investors.
Foreign investors are starting to shun U.S. assets as massive fiscal and current-account deficits are becoming too much to tolerate, according to George Saravelos, head of FX research at Deutsche Bank.
In a recent note to investors, he commented on tepid demand for a 20-year bond auction this past week that sparked a selloff in Treasuries, sending yields higher. But that wasn’t the worst thing about it.
“The most troubling part of the market reaction is that the dollar is weakening at the same time,” Saravelos wrote. “To us this is a clear signal of a foreign buyer’s strike on US assets and the associated US fiscal risks we have been warning for some time. At the core of the problem is that foreign investors are simply no longer willing to finance US twin deficits at current level of prices.”
The jitters in the bond market also come as the U.S. House of Representatives passed legislation to extend tax cuts from President Donald Trump’s first term as well as add new ones, like no taxes on tips and overtime.
While lawmakers are also writing in some spending cuts, they are more than offset by reductions in tax revenue as well as increased outlays elsewhere, such as in defense. The net effect would be trillions of more dollars added to the budget deficits over the next decade.
The Senate is expected to seek changes to the House’s bill, but tax cuts are a top priority for Trump and congressional Republicans.
Saravelos said there are only two ways to restore the attractiveness of U.S. assets to foreign investors.
“Either the US has to sharply revise the current reconciliation bill currently sitting in Congress to result in credibly tighter fiscal policy; or, the non-dollar value of US debt has to decline materially until it becomes cheap enough for foreign investors to return,” he wrote.
Another headwind that U.S. assets face is bond market drama in Japan, which is facing a fiscal crisis of confidence and soaring yields too.
The largest overseas holder of U.S. debt has its own mountain of debt just as its economy is beginning to shrink, with Prime Minister Shigeru Ishiba saying Japan’s fiscal situation is “worse than Greece’s.” On Monday, yields on Japan’s 40-year bond hit highs not seen in some 20 years.
But for Saravelos, higher yields for Japanese government bonds aren’t a reflection of fiscal concerns over the government in Tokyo. If that was the case, the yen would be selling off. Instead, the yen has rallied against the dollar, indicating less participation in the market for U.S. debt.
“We would argue the JGB sell-off is a bigger problem for the US treasury market: by making Japanese assets an attractive alternative for local investors, it encourages further divestment from the US,” Saravelos explained in a separate note this week.
What Japanese investors do is critical to the bond market as the latest official U.S. data show that Japan’s holdings of U.S. debt ticked higher to $1.13 trillion in March—roughly a quarter of its GDP.
Meanwhile, China has been shedding its stockpile of Treasury bonds, which fell to $765 billion at the end of March from $784 billion in the previous month. That pushed China down the list as the third largest holder of U.S. Treasuries, with the U.K. overtaking it to become No. 2.
“At the core of our views in coming months is that the market is becoming increasingly driven by external asset positions, and this is putting combined downward pressure on US bond markets and the USD,” Saravelos said.
