US Treasuries—Buyers still exist, but at a price

The recent rise in US Treasury (UST) yields has reignited a familiar but important debate: Who ultimately becomes the marginal buyer of US debt at a time when deficits remain large, debt-servicing costs continue to rise and inflation risks are exacerbated by the Iran-related oil supply shock?

Over the last several years, the traditional sources of UST demand have evolved materially. The Federal Reserve is no longer aggressively expanding its balance sheet through quantitative easing (QE), foreign central banks aren’t accumulating reserves at the same pace seen during earlier decades and some sovereign investors are diversifying portions of their portfolios into gold and non-US sovereign assets. At the same time, UST issuance continues to expand against a backdrop of persistent fiscal deficits and higher refinancing costs. That combination naturally raises questions about whether the market can comfortably absorb the growing supply of US debt.

The concern becomes even more relevant in an environment where higher energy prices risk feeding into inflation expectations, pushing yields and financing costs higher across the curve. In practical terms, higher inflation expectations can lead to higher nominal and real yields, increasing the coupon required on new issuance and ultimately raising the government’s interest burden over time.

That said, supply and demand dynamics aren’t the only forces influencing long-term yields. Investors are also trying to assess whether inflation over the next decade will behave differently than it did during much of the post-global financial crisis (GFC) period. Rising energy demand, AI-related infrastructure spending, shifting supply chains, labor constraints and geopolitical fragmentation all raise questions about whether inflation may prove more persistent than many investors became accustomed to between 2009 and 2020. That uncertainty alone may lead investors to demand greater compensation when lending over longer horizons.

However, there’s an important distinction that investors should keep in mind. In our view, the risk isn’t necessarily an imminent failure of UST demand, but rather that the market will now require a higher clearing yield to attract sufficient buyers. Those are two very different things.

The recent rise in yields may itself be evidence that the adjustment mechanism is already functioning. For years, portions of UST demand were relatively price insensitive. Central bank reserve accumulation, QE programs and regulatory dynamics helped create a steady structural bid for US government debt regardless of valuation. Today, a growing share of demand is becoming more price-sensitive and more yield-dependent. As a result, the UST market may require higher yields to entice buyers—pensions, insurance companies, households, bond funds, banks and foreign private investors seeking income, liquidity and relative safety. In the near term, domestic institutions, money market funds and private investors may absorb a growing share of issuance. Over longer horizons, the role of foreign reserve managers, pension reallocations and global institutional demand will remain important in determining the long-run clearing level for yields.

No one can confidently determine whether long-end UST yields ultimately stabilize at 5%, 5.5% or higher, but history suggests that at sufficiently attractive yield levels, demand tends to emerge. This is especially true in a global fixed income landscape where many developed markets continue to face their own structural challenges including weak growth, aging demographics, fiscal pressures and geopolitical uncertainty.

It bears reminding that despite concerns surrounding US deficits, the UST market remains the deepest and most liquid sovereign bond market in the world, and during periods of volatility or uncertainty, global capital still tends to migrate toward liquidity and scale. According to the latest US Treasury Department data, foreign ownership of USTs remains sizable in absolute terms, even though foreign private investors are playing a larger role while some official reserve managers continue gradually diversifying portions of their reserves into other assets.

Given all this, the current debate shouldn’t be framed around sensational predictions that USTs suddenly become “unfinanceable” or that foreign buyers disappear overnight. The more relevant issue is whether the market is transitioning toward a world in which investors require a higher term premium to absorb a growing supply of debt while also navigating greater uncertainty around inflation, fiscal policy and long-term economic growth.

None of this means the US Treasury market is on the verge of dysfunction, but it does suggest the US may be entering a period when financing large deficits becomes more expensive relative to what investors became accustomed to during the post-GFC era. Even if UST markets continue functioning normally, that adjustment still matters because higher borrowing costs tighten financial conditions and increasingly constrain fiscal flexibility over time.