“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.
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.
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.
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.
