US Treasury demand plummets as foreign holders of US debt are losing their appetite. The latest data shows foreign holdings of US government debt declined for a third straight month.
Crucially, Chinese holdings fell to $1.168 trillion in January and are in steady decline. That was the lowest in six months. China is the US government’s biggest foreign creditor. Accordingly, a sustained decline in Chinese appetite for US government debt is a big problem for the US government’s ability to finance itself.
Moreover, Japan is also steadily reducing its exposure to US government debt. The Japanese have cut their holdings of US Treasuries five of the last six months. Japan is the second largest foreign holder of US Treasuries.
What’s more, US government debt demand is likely to fall much further in the coming months.
Two major reasons why US Treasury demand plummets in the coming year
First, the US government’s finances are a mess. President Trump has blown out the deficit by cutting taxes for corporations while boosting spending. The US budget deficit could easily top $1.2 trillion next fiscal year — which starts in October 2018.
Investor appetite for US government bonds will decline as the budget deficit blows out.
On top of that, President Trump is pushing to start a trade war with the US government’s biggest creditor, China. This is a terrible idea in the best of times. Even more so when the US government is bleeding red ink and needs China to buy its ever-growing supply of debt.
Indeed, China’s first move in a full-on trade war might be to dump all of its US government debt. That would throw the US economy into financial crisis as investors flee US Treasuries and send interest rates soaring.
Finally, the Federal Reserve (Fed) has started to taper its bond-buying program. That means the Fed’s switched from a buyer of US Treasuries to a seller. The Fed is ramping up to liquidate about $50 billion worth per month of assets by October.
Assuming about half of that is US Treasuries, the Fed will increase US government debt supplies by $25 billion per month just as demand is drying up. That will inevitably push down US Treasuries prices and force long-term interest rates higher. Interest rates have a converse relationship to bond prices.
Rising interest rates are a harbinger of a slowing economy. That’s because consumers and businesses cut back on spending as interest rates rise due to the rising cost of capital.