Foreign Treasury Holdings Surge to Record High Even as China, Japan Sell US Debt

Sales by Beijing and Tokyo are occurring as the yuan and yen face persistent pressure.

Euro, Hong Kong dollar, U.S. dollar, Japanese yen, pound and Chinese 100 yuan banknotes are seen in this picture illustration, Jan. 21, 2016. REUTERS/Jason Lee/Illustration/File Photo

Foreign holdings of U.S. debt climbed to an all-time high in May, even as China and Japan, the world’s two largest holders of Treasurys, bucked the trend and reduced their exposure to government bonds.

New Treasury International Capital System data on July 18 showed that foreign holdings of U.S. Treasurys increased to a record $8.129 trillion, from an upwardly revised $8.04 trillion in April.

Japan, the top foreign investor in U.S. debt, reduced its portfolio of Treasurys by $22 billion to $1.128 trillion. Japanese holdings are up 3 percent from a year earlier.

Market watchers have been closely following Tokyo’s management of its U.S. government debt holdings as officials try to support the Japanese yen.

The yen has been trading at a three-decade low against the dollar. To reverse this trend, currency authorities have been intervening in the foreign exchange market since April by selling dollars and buying yen.

China, the world’s second-largest holder of Treasurys, shed a little more than $2 billion to $768.3 billion. China’s holdings are down about 10 percent since May 2023.

Like Japan, China’s currency has been weakening this year, with the offshore yuan down more than 2 percent year-to-date. Last year, Chinese state banks were selling the greenback to purchase the yuan to slow the currency’s depreciation.

Other notable buyers of U.S. debt in May were the United Kingdom ($13 billion), Canada ($16 billion), and Ireland ($10 billion). Aside from Beijing and Tokyo, only Hong Kong (negative $3 billion) and Switzerland (negative $1 billion) reduced their stakes.

Federal debt held by foreign and international investors as a percent of gross domestic product is about 28 percent, the lowest in 14 years.

Examining the US Debt Market

Growth in foreign investment of U.S. Treasurys comes as yields have eased on expectations that the Federal Reserve will cut interest rates as early as September.

The benchmark 10-year yield is at 4.21 percent, down from the 2024 peak of 4.71 percent in late April. The 2-year yield is just below 4.5 percent, down from this year’s high of 5.04 percent at the end of April.

For nearly a year, the federal government has been challenged by tepid demand for short- and long-term debt securities, particularly among domestic investors.

The $13 billion auction of 20-year bonds on July 16 resulted in lower demand at home. International buyers scooped up more than 77 percent of the supply, above the six-month average of nearly 70 percent. Additionally, primary dealers—financial institutions that purchase the leftover supply—picked up just 8 percent of the debt securities.

Printing Supervisor Donavan Elliott inspects newly printed sheets of $1 bills at the Bureau of Engraving and Printing in Washington, on March 24, 2015. Mark Wilson/Getty Images

A $44 billion auction of 7-year notes on May 29 resulted in below-average sales, prompting primary dealers to buy 12 percent of the supply.

A chief reason for the lackluster consumption volumes might be the tsunami of supply.

Over the past 12 months, the supply of T-bills—short-term government debt obligations lasting four to 52 weeks—has risen by about $2 trillion. That could be a problem, says Torsten Slok, the chief economist at Apollo.

“A big increase in supply requires a big increase in demand,” said Mr. Slok in a research note this month. “Growing the amount of T-bills outstanding while the Fed at the same time is doing QT [quantitative tightening] increases the risk of an accident in funding markets.”

The central bank has been trimming its balance sheet by reducing its holdings of Treasury securities. However, the Fed recently announced that it will slow the size of its runoff campaign by $30 billion, meaning that policymakers will reinvest in Treasurys, and provide “overall support to these securities,” Althea Spinozzi, the head of fixed income strategy at Saxo, said in an analyst note this month.

There is debate as to whether the Fed lowering interest rates in the next few months would help or hurt the bond market.

Mr. Slok said that should the Fed start lowering the policy rate in the next few months, “we could see lower appetite for T-bills from households and money market funds, which ultimately would put upward pressure on short rates because of the big supply of T-bills not being met by similar strong demand.”

However, Ms. Sponizzi said she thinks it will be hard to anticipate spikes in yields this summer as officials continue “reassuring that significant progress has been made in fighting inflation and that it will continue.”

“However, long-term investors should consider whether a short-term rally in U.S. Treasuries will be sustainable in the long run,” she said. “The possibility of an economic acceleration once the Fed begins to cut rates is not remote, especially if the stock market continues to reach new highs.”

Recent Treasury estimates suggest that the federal government doesn’t intend to slow borrowing.

This past spring, the Treasury Department announced that it plans to borrow more than $1 trillion in the second half of fiscal year 2024. Additionally, it confirmed that the Treasury borrowed $748 billion in the January to March quarter of the current fiscal year.

Still, despite the tsunami of Treasurys, the bond market has been relatively calm compared to the fall of 2022, when the UK’s mini-budget sparked mayhem in long-dated British government bonds, known as gilts. Thirty-year gilt yields surged as much as 155 basis points from Sept. 4 to Oct. 16, 2022.

It doesn’t mean conditions will remain ebullient.

In April, the International Monetary Fund (IMF) warned that “something will have to give,” since the U.S. is the largest government bond market in the world.

“The fiscal stance, out of line with long-term fiscal sustainability, is of particular concern. It raises short-term risks to the disinflation process, as well as longer-term fiscal and financial stability risks for the global economy,” said IMF chief economist Pierre-Olivier Gourinchas.

The U.S. national debt is inching toward $35 trillion. The Congressional Budget Office (CBO) estimates the federal government will post a budget deficit of $1.9 trillion this year, up from the previous forecast of $1.5 trillion. Annual interest payments are expected to top $1 trillion, functioning as the second-largest budgetary item.