WEBVTT - Here's Why America's Debt is a Trade War Victim

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<v Speaker 1>Bloomberg Audio Studios, Podcasts, radio News. I'm Stephen Carroll, and

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<v Speaker 1>this is Here's Why, where we take one new story

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<v Speaker 1>and explain it in just a few minutes with our

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<v Speaker 1>experts here at Bloomberg. Bond market is very tricky.

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<v Speaker 2>I was watching it, but if you look at it now,

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<v Speaker 2>it's beautiful. The bond market right now is beautiful.

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<v Speaker 1>But yeah, I saw last night where people were getting

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<v Speaker 1>a little queasy. Donald Trump's trade tariffs have investors on edge.

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<v Speaker 1>The wild swings in prices of US government debt and

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<v Speaker 1>the volatility and borrowing costs that comes with it have

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<v Speaker 1>been the most glaring example of a loss of confidence

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<v Speaker 1>in what's long been considered a safe investment. Foreign investors

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<v Speaker 1>hold trillions of dollars in treasuries, so what happens if

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<v Speaker 1>they decide to put their money elsewhere.

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<v Speaker 2>Japan and China are two of the largest holders of

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<v Speaker 2>US treasuries, and if they decide that they don't want

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<v Speaker 2>to show up an auction, it's going to be very tricky.

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<v Speaker 1>I think what the treasury market is telling us is

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<v Speaker 1>that there is not a lot of balance sheet availability

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<v Speaker 1>to absorb all this treasury selling. Twenty twenty five feels

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<v Speaker 1>like a US driven situation and willingness on the part

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<v Speaker 1>of foreign investors to liquid date dollar assets. Treasuries are

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<v Speaker 1>part of that complex. Here's why America's debt is a

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<v Speaker 1>trade war victim. Our managing editor for FS and Rates,

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<v Speaker 1>Rachel Evans, joins me. Now for more. Rachel, First of all,

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<v Speaker 1>how important are foreign buyers for US government borrowing?

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<v Speaker 2>Very important. They comprise about a third of ownership for

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<v Speaker 2>the treasury market, so it's a significant piece of the pie.

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<v Speaker 2>And there's some analysis out there from Barklay's that that's

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<v Speaker 2>interesting that suggests that last year so foreign buyers were

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<v Speaker 2>really taking down like a large chunk of the debt

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<v Speaker 2>issuance that the US was putting out there. These are

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<v Speaker 2>all different types of owners. You've got pension funds, you've

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<v Speaker 2>got insurers, and you've also got central banks that are

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<v Speaker 2>sticking these into their reserves theoretically as kind of a

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<v Speaker 2>pillar of stability for themselves.

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<v Speaker 1>The term buyer strike might sound quite encendry in a

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<v Speaker 1>lot of ways, but what would a buyer's strike look

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<v Speaker 1>like in the US treasury markets?

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<v Speaker 2>Yeah, I think, simply put, and we haven't really seen

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<v Speaker 2>this necessarily, so it's kind of hard to exactly what

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<v Speaker 2>it would look like, but simply put, you would see

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<v Speaker 2>yields continually rising day after day, and particularly at the

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<v Speaker 2>long end. When we look at kind of the division

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<v Speaker 2>of the types of treasuries that are owned by foreign buyers,

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<v Speaker 2>it tends to skew towards longer dated debts, so thirty

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<v Speaker 2>year debts. So if you're starting to see yields really

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<v Speaker 2>kind of rocketing up at the long end in thirty

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<v Speaker 2>year debt, boring costs really sawing their day after day

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<v Speaker 2>after day, that would be an indication that you're starting

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<v Speaker 2>to see foreign buyers pulling back, and.

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<v Speaker 1>So far, no sign of that that we've seen in markets.

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<v Speaker 2>We've seen little dribs and drabs, but we haven't kind

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<v Speaker 2>of seen the sort of the prolonged action that you

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<v Speaker 2>would necessarily sort of view as being kind of a

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<v Speaker 2>bier strike. We had a slightly iffy auction earlier in

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<v Speaker 2>the week where we saw year debt sort of struggling

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<v Speaker 2>to find as much demand as it might sometimes, and

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<v Speaker 2>we've seen steeper yield cup so that the back end

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<v Speaker 2>of the curve selling off more those yields on thirty

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<v Speaker 2>year debt rising more so that does indicate sort of

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<v Speaker 2>the potential for demand overall is kind of diminishing a

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<v Speaker 2>little bit. And I was also taken by some analysis

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<v Speaker 2>that our colleague Cameron Christ did that suggested that since

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<v Speaker 2>Trump's inauguration, we've actually seen most selling outside of US hours.

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<v Speaker 2>So that tells you that in terms of who is

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<v Speaker 2>doing the selling, that it is often coming from overseas.

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<v Speaker 2>So there's been these kind of little hints of unease

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<v Speaker 2>I think amongst kind of foreign investors, but we've not

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<v Speaker 2>seen kind of the action that would suggest sort of

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<v Speaker 2>a or bona fide by a strike that's really going

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<v Speaker 2>to be there for the longer term.

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<v Speaker 1>So we're determined to sort of pullback that we would

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<v Speaker 1>term a strike in this context. I mean, if it

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<v Speaker 1>were to happen, theoretically, what would a last of foreign

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<v Speaker 1>interest in US debt mean for the US government?

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<v Speaker 2>I mean very simply higher yields, so higher borrowing cost

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<v Speaker 2>for the US government. They would need to pay more

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<v Speaker 2>to refinance their debt and to borrow new money. That

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<v Speaker 2>would also have a ripple through effect to things like

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<v Speaker 2>mortgage rates, which track ten year yields and are therefore

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<v Speaker 2>would also be going up so you'd be getting kind

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<v Speaker 2>of that ripple through effect from the US's borrowing costs

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<v Speaker 2>through to sort of the average Americans foreign costs and

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<v Speaker 2>their debt load. You'd also potentially see the US government

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<v Speaker 2>have to rethink how it sells debt. At the moment,

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<v Speaker 2>you know, you have kind of a balance between sort

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<v Speaker 2>of short dated bonds and longer dated securities that's kind

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<v Speaker 2>of set by Treasury to sort of tap into investor interest. Now,

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<v Speaker 2>Scott Bessen has said that he would like to move

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<v Speaker 2>away from having so much debt at the short end

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<v Speaker 2>of the curve, so many bills. He wants more longer

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<v Speaker 2>term debt. However, if your cost of longer term debt

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<v Speaker 2>is skyrocketing upwards, that becomes very very difficult, and the

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<v Speaker 2>need to really issue more short data debt that you

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<v Speaker 2>can pay less on becomes higher. So I think you

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<v Speaker 2>just sort of have to see that the government recalibrating

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<v Speaker 2>how it sells debt in order to make sure that

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<v Speaker 2>it's tapping the investors that do stick around.

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<v Speaker 1>Would the Federal Reserve get involved in this, Whether there

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<v Speaker 1>be a moment at which something would get so dramatic

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<v Speaker 1>that the Central Bank would have to act.

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<v Speaker 2>So the central Bank has it's obviously economic mandate where

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<v Speaker 2>it's thinking about inflation and growth and jobs, so this

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<v Speaker 2>doesn't necessarily impinge on that. They're also looking at kind

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<v Speaker 2>of market functioning. So I think where the FED might

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<v Speaker 2>get involved is where if you see some dislocations and

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<v Speaker 2>some breakages and how the market functions.

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<v Speaker 1>Being extremely abnormal essentially exactly.

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<v Speaker 2>I mean, this is sort of what we saw back

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<v Speaker 2>in like March twenty twenty, when we saw kind of

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<v Speaker 2>a huge liquidation of pretty much every assets but a

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<v Speaker 2>dash for cash, and that really kind of sort of

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<v Speaker 2>broke some of the plumbing in the markets. We saw

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<v Speaker 2>a lot of hedge fund trades and winding very very rapidly,

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<v Speaker 2>and the FED did step in then with various kind

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<v Speaker 2>of facilities to try and kind of ease some of

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<v Speaker 2>the liquidity constraints that were really sort of upsetting the

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<v Speaker 2>market at the time. So there has been some sort

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<v Speaker 2>of conversation in markets about, you know, whether the FED

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<v Speaker 2>could intervene or how they'd intervene. So speculate that maybe

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<v Speaker 2>they could step in and do sort of emergency qe,

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<v Speaker 2>you know, stepping into buy bonds. Others say, no, that's

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<v Speaker 2>not likely, but maybe we could see sort of exemptions

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<v Speaker 2>from the so called supplementary leverage ratio. So the SLR

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<v Speaker 2>kind of restricts how much dealers can have on their

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<v Speaker 2>balance sheet in terms of treasuries. If you suspended that,

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<v Speaker 2>people might have a little bit more room to kind

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<v Speaker 2>of manage a rapid sell off. So there's kind of

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<v Speaker 2>conversations about that, but we haven't got to a point

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<v Speaker 2>yet where those dislocations are particularly severe. In fact, you're

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<v Speaker 2>looking kind of at funding markets. While we are seeing

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<v Speaker 2>sort of an increasing cost, it's still relatively contained and

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<v Speaker 2>I think Beth Hammock of the Cleveland Feds or described

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<v Speaker 2>them as as strained but sort of working.

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<v Speaker 1>Okay, so question marks over that safe haven status rather

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<v Speaker 1>than necessarily a serious attack on us.

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<v Speaker 2>Yeah, I mean, I think what we will see. I mean,

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<v Speaker 2>we are seeing kind of like rallies in European bonds

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<v Speaker 2>this week, and they're providing kind of an alternative to

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<v Speaker 2>those who are seeking havens. I think, you know, there's

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<v Speaker 2>a lot of bigger questions, you know, just kind of

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<v Speaker 2>given this very volatile period we've had since kind of

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<v Speaker 2>the tariff announcement, to what degree, you know, investors overseas

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<v Speaker 2>continue to view treasuries as ballast or is it a

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<v Speaker 2>kind of stable asset that they want to hold as

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<v Speaker 2>a haven. Obviously, the US is still deeply embedded in

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<v Speaker 2>the financial system. This is still a very kind of

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<v Speaker 2>dollar dominated financial system, So that's not going to change overnight,

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<v Speaker 2>but you know, you do sort of see kind of

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<v Speaker 2>subtle shifts happening over years. And I mean a lot

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<v Speaker 2>of people have talked about whether China could, for example,

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<v Speaker 2>get out of its treasury holdings, and there's no indication

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<v Speaker 2>of that happening immediately, but they have been reducing those

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<v Speaker 2>gradually over the last decade.

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<v Speaker 1>Because as we see trade engines with China ramping up,

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<v Speaker 1>is this actually something that could be was a conscious

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<v Speaker 1>decision that might come from Beijing, which would go beyond

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<v Speaker 1>just investors looking elsewhere for more stable investments, but perhaps

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<v Speaker 1>actually a tool in the trade war.

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<v Speaker 2>Yeah, I mean, it's it's a good question to ask,

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<v Speaker 2>and I think you know, a lot of people are wandering,

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<v Speaker 2>given we're in pretty unprecedented times, whether unprecedented trade war

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<v Speaker 2>tools could be deployed. I mean, the Chinese government tends

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<v Speaker 2>to take a more long term picture about these things.

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<v Speaker 2>I mean, as I mentioned, they've been kind of winding

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<v Speaker 2>down some of their treasuries holdings over the last decade.

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<v Speaker 2>You know, they were at one point holding I think

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<v Speaker 2>one point three trillion dollars of US debt that's now

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<v Speaker 2>down to about seven hundred billion, And in fact, Japan

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<v Speaker 2>is now the largest holder overseas of treasuries. So China

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<v Speaker 2>doesn't necessarily have to move kind of immediately, and like

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<v Speaker 2>particularly with great speed, they have a very long term

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<v Speaker 2>view on how to kind of change their policy. But

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<v Speaker 2>it's certainly a kind of underlying concern that they could

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<v Speaker 2>start dumping treasuries at the moment, though, it seems more

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<v Speaker 2>likely that they're going to manage the currency exchange rate

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<v Speaker 2>as kind of their tool as a bit of a

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<v Speaker 2>release volve for some of the pressures that have been

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<v Speaker 2>building up in relation to tariffs.

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<v Speaker 1>Okay, Rachel Evans are managing editor for FX and Rates.

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<v Speaker 1>Thank you for more explanations like this from our team

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<v Speaker 1>of three thousand journalists and analysts around the world, go

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<v Speaker 1>to Bloomberg dot com slash explainers. I'm Stephen Carroll. This

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<v Speaker 1>is here's why. I'll be back next week with more.

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<v Speaker 1>Thanks for listening.