This short note aims to decipher a striking chart related to current economic events. This Killer Chart looks at international holders of US public debt securities and recent trends.
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Why is this interesting?
While the outcome of the 2024 US elections was difficult to predict, there was one issue about which there was little doubt in the United States: the widening public deficit and rising public debt.
In October 2024, the Committee for a Responsible Federal Budget estimated that the fiscal impact of the elected candidate’s campaign promises would reach between USD 4 trillion and USD 8 trillion. These are colossal sums, given that the level of public debt in the United States is already at record highs (124% of GDP for fiscal year 2024). Far from the European debates on the urgent need to consolidate public finances, the United States is therefore counting on increased budgetary support.
Is this boldness or a headlong rush? To answer this question, we need to determine who is in a position to absorb these additional amounts of debt, which are a corollary of deficits and rising public debt.
Some analysts are questioning this, given that the Federal Reserve (Fed) is simultaneously reducing its exposure to US sovereign debt securities and the appetite for these securities in certain regions of the world (Japan, some BRICS countries) appears to be waning. In other words, there is more supply and less demand.
What should we make of this?
In 2020-2021, the public debt surplus generated by the Covid-19 crisis in the United States was mainly absorbed by the domestic banking sector (Fed and commercial banks). Committed to reducing its balance sheet through its quantitative tightening policy, the Fed is now expected to provide less support by only partially refinancing the sovereign bonds it holds that are reaching maturity, which will reduce market depth and liquidity, all other things being equal.
In the short term, this would not necessarily mean an increase in sovereign yields, as the Fed is currently in a cycle of reducing key interest rates, favoring a decline in yields along the yield curve. However, it could lead to slightly more volatility in bond yields in the medium term, representing a « return to normal » after a nearly 15-year hiatus of unconventional monetary policies. The impact on the US dollar (USD) remains more ambiguous[2] but will likely be decisive in ensuring that US debt securities remain attractive in some form.
Attractiveness will be a decisive factor, especially since 2022, when the rapid rise in US bond yields, linked to the Fed’s monetary tightening, sparked renewed interest among non-resident investors in US sovereign debt (see chart[3]). However, some countries seem less « hungry » for US securities, notably China, whose holdings of US securities have fallen sharply[4]. Is this cause for concern about a new trend in which certain countries are no longer interested in US sovereign securities?
As mentioned in another Killer Chart published by BSI Economics, we should not jump to conclusions about a wave of « rejection » of US debt securities. The case of Japan[5] seems quite specific and appears to be a response to investment arbitrage (see this article). There is also a scenario in which demand for US securities remains very strong, or even increases, whether for regulatory reasons (to meet capital requirements for the financial sector, for example) or for investment strategy arbitrage (search for yield or safe haven[7]).
Among the BRICS countries, whose holdings of US bonds have declined in recent years, it is important to differentiate between the various cases.
The case of Brazil is fairly emblematic[7] in that the decline in US bond holdings since 2020 coincides with a contraction in foreign exchange reserves linked to i) the Covid crisis, then ii) pressure on the real in an inflationary environment. The sale by the central bank of the most liquid foreign exchange reserves, such as US bonds, is a traditional monetary mechanism in emerging economies to cope with pressure on their currency. These countries are required to regularly rebuild their foreign exchange reserves to absorb potential shocks. However, at this stage, while other assets (denominated in euros or gold, for example) are particularly attractive for diversifying foreign exchange reserves, USD-denominated assets remain among the most widespread and liquid.
In China, the decline in US bond holdings is linked to economic and geopolitical factors. Since 2021, the volatility of the yuan due to a very accommodative monetary policy has, as in Brazil, required the central bank to intervene by selling USD-denominated foreign exchange reserves[9]. This trend is not necessarily set to continue. Since the end of 2022, Hong Kong, China’s offshore financial center, has once again increased its holdings of US bonds. Political factors, on the other hand, may temporarily dampen demand for US securities (as was the case during the 2018 trade war or when tensions arose over Taiwan). The case of Russia is even more telling, where the desire to avoid further sanctions may even lead to the sale of USD-denominated assets.
It is difficult to judge the real sustainability of the trajectory of US public finances. However, while the absorption of this excess public debt will take place in an environment that is likely to be less favorable than previous episodes of sharp increases in debt since 2008, current indicators do not seem to reveal any real paradigm shift at the international level at this stage.
[1] As a result, the share of US holders of public debt securities has increased relatively to just over 75% of the total (+5 pts compared to the 2019 average).
[2] An accommodative policy mix (fiscal stimulus and lower interest rates) would normally be accompanied by a relative decline in the value of the USD. However, the search for liquid USD-denominated assets, whether by residents or non-residents, tends to generate positive net capital inflows, thereby supporting the value of the USD. Furthermore, the success of the US policy mix will likely be judged on its ability to generate real GDP growth and strengthen competitiveness, both of which are favorable factors for attracting capital and enhancing the appeal of the USD.
[3] USD 8,503 billion in Q3 2024, compared with USD 7,600 billion in Q1 2022 and USD 6,900 billion in Q4 2019.
[4] In Q3 2024, China held nearly USD 775 billion in US sovereign bonds, compared with nearly USD 1,040 billion at the beginning of 2022 and USD 1,170 billion at the beginning of 2018 (peaking at nearly USD 1,200 billion in 2015).
[5] In Q3 2024, Japan held USD 1,130 billion in US sovereign bonds, compared with a peak of USD 1,300 billion in Q4 2021.
[6] For example, in a hypothetical scenario of deteriorating public finances in the eurozone, the appeal of US bonds would also likely increase.
[7] Brazil held USD 233 billion in US sovereign bonds in Q3 2024, down from a peak of nearly USD 310 billion in mid-2019.
[8] This is particularly true in emerging economies that are highly integrated financially and whose capital flows are sensitive to investment arbitrage (Mexico, South Africa, Brazil, Indonesia, and Turkey, for example).
[9] During periods of economic tension in China, US debt levels tend to fall, with the current real estate crisis echoing that of 2015-2016.
