Who Will Buy US Debt?

Despite Jay Powell’s clear message on the FOMC’s reluctance to engage in pre-emptive cuts, the market has revised down its expectations for the Fed Funds’ trajectory, probably reacting to another round of direct comments from D. Trump on the central bank’s stance. Naming the next Fed President well ahead of the end of Powell’s term – materialising the much talked-about “shadow Fed” scenario – could be the harbinger of lasting volatility. Beyond the risk of contradictory signals in the months ahead, bringing Fed Funds into clear accommodative territory without the right dataflow to back it – assuming this would be the choice of D. Trump’s appointee – would likely be opposed by a majority of the FOMC. Central bank leaders can at times be put in a minority – this has happened at the Bank of England. But the Fed is not the BoE. Given its history, this would affect its credibility. 

This is still a theoretical discussion, but all this noise is already having a tangible effect on the dollar, which continues to weaken. The expected rate differential with Europe is now narrowing faster, which adds to the generic discomfort with the US currency overseas triggered by the fiscal outlook and threats to the central bank’s independence. As the Senate is about to vote on the “Big Beautiful Budget Bill”, questions on the funding of the US fiscal deficits are getting more urgent. While the market commentariat is focusing on the very latest signs of international reallocation, a striking feature of the last 10 years has been the gradual decline in the share of foreign investors in the US treasury market: domestic players have taken up the slack, with US households, over the last 3 few years, bringing a decisive contribution. In the long run, maintaining this pattern would probably require a rise in the personal savings ratio, which for now has remained elusive. The quest for the next marginal buyer is now shifting to US banks. A proposition by US regulators last week would free up some significant space for US banks to participate more in the treasury market. This could offer some respite in the short run, but even if such changes in regulation can “nudge” towards treasuries, US banks have already been raising their sovereign exposure a lot these last 15 years. Beyond the technical changes, there could be fundamental limits to such approach.