Author: Research Report Jun; Source: Research Report Digest
The rapid growth of the US national debt has attracted widespread attention. According to the latest forecast by Bank of America, if the US debt continues to grow at the rate of the past 100 days (an increase of $907 billion), the total amount of US national debt will surpass $40 trillion on February 6, 2026. This figure is shocking - considering that it took over 200 years for the United States to accumulate the first $10 trillion in national debt since its founding, and now it may add $10 trillion in just 400 days. At the same time, US government spending increased by 11% year-on-year to reach $7 trillion, and there are no signs of significant improvement in this fiscal expansion trend in the short term.
Faced with such a huge supply, the market naturally cares: who will ultimately pay for these government bonds? Especially against the backdrop of the Fed’s continued push for quantitative tightening (QT), there is great uncertainty about the purchasing power and willingness of institutional investors, traditionally considered the main buyers.
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PART ONE Buyer 1: Pension Funds and Insurance Companies
Let’s start with the two major institutional investors, pension funds and insurance companies. Although they manage trillions of assets, they are not particularly keen on buying US Treasury bonds directly. Taking private pension funds as an example, their holdings of US Treasury bonds account for only 3% of their total assets, while state and local government pension funds hold only about 5%. These institutions prefer to use derivatives to hedge interest rate risks and invest cash in higher-yielding assets such as credit bonds and structured products. The holdings of US Treasury bonds by life insurance companies have remained stable over the past 25 years without significant growth. Even property insurance companies, which have seen increased liquidity demand due to extreme weather and other factors in recent times, have only doubled their holdings of US Treasury bonds as a proportion of total assets from a lower level.
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PART TWO Buyer Two: Bank
The situation of the banks is also very interesting. On the surface, the proportion of US Treasury bonds held by banks as a percentage of their total assets has risen from less than 2% before the 2008 financial crisis to 6% now, but this is mainly due to regulatory requirements. In fact, banks do not take on too much interest rate risk. The long-term US Treasury bonds they purchase are often hedged against interest rate risk through asset swaps and other means. Regulatory agencies also do not want banks to take on too much interest rate risk. Even if regulations are relaxed in the future, such as excluding US Treasury bonds from the calculation of the supplementary leverage ratio (SLR), this will mainly improve the liquidity of the US Treasury repurchase market, rather than significantly increase the actual demand for US Treasury bonds by banks.
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PART THREE Buyer Three: Hedge Fund
Hedge funds have indeed increased their holdings of US Treasury bonds recently, which has played an important role in providing market liquidity. However, it should be noted that their positions are often based on various arbitrage trades and do not represent long-term demand for US Treasury bonds. From the statements of regulatory agencies such as the Bank for International Settlements (BIS), the Bank of England, and the Bank of Canada, they are concerned about the growing intermediary role of hedge funds in the US Treasury market. Once market volatility increases or regulatory tightening occurs, hedge funds are likely to be forced to reduce their holdings of US Treasury bonds.
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PART FOUR Buyer Four: Foreign Central Bank
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Foreign central banks were once among the most important buyers of US Treasuries. In the early 2000s, countries such as Japan and China accumulated a large amount of US dollar assets and invested in US Treasuries to maintain exchange rate stability. However, the situation has fundamentally changed - in the environment of a stronger US dollar, many central banks have had to sell US Treasuries to obtain US dollars to maintain their domestic currency exchange rates. Some central banks have even preemptively reserved a large amount of US dollars in the Federal Reserve’s foreign exchange reverse repurchase agreement (RRP) tool to deal with potential exchange rate pressure. Unless the US dollar significantly weakens, the demand for US Treasuries from foreign official sectors is expected to remain weak.
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PART FIVE Buyer Five: Overseas Private Investors
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Whether private overseas investors are willing to buy US bonds depends mainly on two factors: the relative attractiveness of yields and exchange rate risk.
Let’s use a simple example to illustrate. Suppose a Japanese investor is considering whether to buy Japanese government bonds or US government bonds. If the yield on Japanese government bonds is 1% and the yield on US government bonds is 4%, it seems more cost-effective to buy US bonds. But the problem is not so simple, because this investor faces exchange rate risk - if the US dollar depreciates by 10% during the holding period, the 4% yield may turn into a real loss of -6%.
To mitigate this exchange rate risk, investors can use financial derivatives to hedge against it. However, hedging comes at a cost, which depends mainly on the shape of the interest rate curves of the two countries. Simply put, if the long-term interest rates in the United States are much higher than the short-term interest rates (i.e., a steep yield curve), the hedging cost will be relatively low; otherwise, if the difference between long-term and short-term interest rates in the United States is small (i.e., a flat yield curve), the hedging cost will be higher.
In recent years, the yield curve of US Treasury bonds has been relatively flat compared to other developed markets. This means that overseas investors may not be better off buying bonds in their own country if they fully hedge against exchange rate risk. For example, suppose a European investor, after hedging against exchange rate risk, buys 10-year US Treasury bonds, the actual yield may be only 2%, while the yield of German government bonds during the same period is 2.5%. Obviously, buying US bonds lacks attractiveness.
Of course, if investors are optimistic about the trend of the US dollar, they may choose not to hedge the exchange rate risk or only hedge a part of it. Indeed, against the backdrop of the continued strength of the US dollar in the past few years, many overseas investors have done so. However, this strategy also carries risks - if the US dollar begins to weaken, these investors may have to start hedging exchange rate risks, and once they start hedging, the advantage of holding US debt securities may disappear. In this case, they are likely to choose to reduce their holdings of US debt and invest in other assets instead.
In short, for overseas private investors, buying US bonds not only requires considering the surface yield, but also weighing the exchange rate risk and hedging costs. In the current market environment, these factors combined may dampen their enthusiasm for buying US bonds. That’s why the market is concerned that, in the case of a significant increase in supply, overseas private investors may not necessarily become stable buyers.
Overall, while the supply has increased significantly, the purchasing power and willingness of traditional buyers are facing challenges. This supply-demand imbalance implies that the US bond market may need higher yields to attract sufficient demand. Of course, if economic growth slows down, safe-haven demand may drive various investors to increase their holdings of US bonds. Regulatory reforms theoretically may also create some new demand, but UBS analysis suggests that this effect may be limited. In the current macro environment, the achievement of supply-demand balance in the US bond market remains uncertain.
What’s even more worrying for the market is that such a huge debt burden also brings potential default risks. Although the possibility of a sovereign debt default in the United States, as the world’s largest economy and the issuer of the US dollar, is extremely low, even a short-term technical default could trigger serious financial market turbulence.
This is because U.S. Treasuries play a unique and critical role in the global financial system. They are not only the most important “safe asset” globally, but also serve as the benchmark for financial market pricing and play a core role in collateralized borrowing and derivative transactions. Taking the repo market as an example, U.S. Treasuries are the main collateral, supporting trillions of dollars in short-term financing every day. If U.S. Treasuries were to default, this market could immediately be paralyzed.
In addition, US bonds are also the most important liquidity reserve for global financial institutions. Banks, insurance companies, pension funds and other institutions hold a large amount of US bonds as a liquidity buffer. Once the price of US bonds experiences drastic fluctuations or liquidity dries up, these institutions may be forced to sell off assets, triggering a chain reaction. Especially in the current situation where global debt levels are generally high, the drastic fluctuations in the US bond market may transmit to other markets through various channels, triggering a more widespread financial crisis.
In history, in 1979, the United States experienced a brief small-scale debt default due to technical reasons, and the impact at that time was quite significant - leading to a 60 basis point surge in short-term Treasury bond yields, and the financing costs of the Treasury bond market continued to be under pressure in the following months. The current scale and interconnectedness of the US bond market far exceed that of the past, so if a similar situation occurs, the impact will be even more far-reaching.
Therefore, ensuring the smooth operation of the U.S. Treasury market is not only related to the fiscal situation of the United States itself, but also to global financial stability. This is also why various parties are so concerned about the imbalance between the supply and demand of U.S. Treasury bonds. In this context, the U.S. government, the Federal Reserve, and major market participants all need to act cautiously, not only to control the pace of debt growth, but also to maintain market confidence and avoid severe fluctuations. At the same time, other countries also need to plan ahead, moderately diversify reserve assets, and enhance the resilience of the financial system.
The game of supply and demand around US bonds is not only related to the sustainability of US finances, but also to the stability of the global financial system. As the scale of US bonds continues to expand, market attention to this issue will only further increase.
