Author: Research Report Jun; Source: Research Report Intensive Reading

The rapid growth of the U.S. national debt has attracted widespread attention. According to the latest forecast from Bank of America, if U.S. debt continues to grow at the rate of the past 100 days (an increase of $907 billion), the total U.S. national debt will exceed the $40 trillion mark on February 6, 2026. This figure is shocking - you must know that it took more than 200 years since the founding of the United States to accumulate the first 10 trillion US dollars in national debt, and now it is possible to add 10 trillion US dollars in just 400 days. At the same time, U.S. spending increased by 11% year-on-year to US$7 trillion. This fiscal expansion situation shows no signs of significant improvement in the short term.

Faced with such a huge supply, the market is naturally concerned: Who will pay for these government bonds? Especially in the context of the Federal Reserve continuing to promote quantitative tightening (QT), institutional investors, who are traditionally considered the main buyers, have great uncertainty in their purchasing ability and willingness.

PART ONE Buyer 1: Pension funds and insurance companies

Let’s look at pension funds first and insurance companies are the two major institutional investors. Although they manage trillions of assets, they are not actually keen on buying U.S. debt directly. Taking private pension funds as an example, their holdings of U.S. debt only account for 3% of their total assets, while state and local pension holdings only account for about 5%. These institutions prefer to obtain interest rate risk exposure through derivatives and invest cash in assets such as credit bonds and structured products with higher yields. Life insurance companies' U.S. debt holdings have remained stable over the past 25 years, with no significant growth. Even for property and casualty insurance companies, whose liquidity needs have increased recently due to extreme weather and other factors, the proportion of their U.S. bond holdings in total assets has only doubled from a low level.

PART TWO Buyer 2: Bank

The situation with banks is also interesting. On the surface, banks' holdings of U.S. debt as a proportion of their total assets have increased from less than 2% before the 2008 financial crisis to 6% now, but this is mainly due to regulatory requirements. In fact, banks do not bear much interest rate risk. The long-term U.S. debt they purchase often hedges interest rate risk through asset swaps and other methods. Regulators also don't want banks to take on too much interest rate risk. Even if regulations are relaxed in the future, such as excluding U.S. debt from the calculation of the supplementary leverage ratio (SLR), this will mainly changeIt will improve the liquidity of the U.S. bond repo market without significantly increasing banks' actual demand for U.S. bonds.

PART THREE Buyer Three: Hedge Funds

Hedge funds have indeed recently accumulated a large amount of U.S. debt holdings, which has played an important role in providing market liquidity. However, it should be noted that their positions are often based on various arbitrage transactions and do not represent long-term demand for U.S. debt. Judging from the statements of regulatory agencies such as the Bank for International Settlements (BIS), the Bank of England and the Bank of Canada, they have instead expressed concerns about the growing intermediary role of hedge funds in the U.S. debt market. Once market volatility increases or regulations tighten, hedge funds are likely to be forced to reduce their holdings of U.S. debt.

PART FOUR Buyer Four: Foreign Central Banks

Foreign central banks were once among the most important buyers of U.S. debt. In the early 2000s, Japan and other countries accumulated a large amount of US dollar assets and invested in US debt in order to maintain exchange rate stability. But now the situation has fundamentally changed - in a strong dollar environment, many central banks have to sell U.S. debt to obtain dollars to maintain their currency exchange rates. Some central banks have even reserved large amounts of U.S. dollars in the Federal Reserve's foreign exchange reverse repurchase facility (RRP) in advance to deal with possible exchange rate pressures. Unless the dollar weakens significantly, foreign official sector demand for U.S. Treasuries is expected to remain weak.

PART FIVE Buyer Five: Overseas Private Investors

As for whether private overseas investors are willing to buy U.S. debt, it mainly depends on two factors: the relative attractiveness of yields and exchange rate risk.

Let us use a simple example to illustrate. Suppose a Japanese investor is considering whether to buy Japanese government bonds or U.S. government bonds. If the yield on Japanese government bonds is 1% and the yield on U.S. government bonds is 4%, it seems more cost-effective to buy U.S. government bonds. But the problem is not that simple, because this investor faces currency risk - if the dollar depreciates by 10% against the yen during the holding period, a 4% return may turn into a negative 6% real loss.

In order to avoid this exchange rate risk, investors can conduct exchange rate hedging through financial derivatives. But hedging has a cost, and this cost mainly depends on the shape of the interest rate curves of the two countries. Simply put, if long-term interest rates in the United States are much higher than short-term interest rates (i.e., the yield curve is steep), hedging costs will be relatively low; conversely, if long-term and short-term interest rates in the United States are similar (i.e., the yield curve is flat), hedging costs will be will be higher.

In recent years, the U.S. bond yield curve has been relatively flat relative to other developed markets. This means that if overseas investors completely hedge exchange rate risks, it may be more cost-effective to buy bonds themselves. To give a specific example, assuming that after a European investor hedges against exchange rate risk, the actual yield on buying 10-year U.S. bonds may be only 2%, while the yield on German government bonds during the same period is 2.5%, then it is obviously insufficient to buy U.S. bonds. Attractive.

Of course, if investors are optimistic about the trend of the US dollar, they may choose not to hedge exchange rate risks or only partially hedge them. Indeed, in the context of the continued strength of the US dollar in the past few years, many overseas investors have done just that. But this strategy also comes with risks - if the dollar starts to weaken, these investors may have to start hedging currency risk, and once hedging begins, the return advantage of holding U.S. Treasuries may be gone. In this case, they are likely to choose to reduce their holdings of U.S. debt and invest in other assets.

In short, for overseas private investors, when purchasing U.S. debt, they must not only consider the superficial rate of return, but also weigh exchange rate risks and hedging costs. In the current market environment, the combination of these factors may dampen their enthusiasm for buying U.S. debt. This is why the market is worried that when supply increases significantly, overseas private investors may not be able to become stable takeovers.

In general, while supply has increased significantly, the purchasing power and willingness of traditional buyers are facing challenges. This imbalance between supply and demand means the U.S. Treasury market may need higher yields to attract sufficient demand. Of course, if economic growth slows, then safe-haven demand may push various investors to increase their holdings of U.S. debt. Regulatory reform may theoretically create some new demand, but UBS's analysis believes that this effect may be limited. In the current macro environment, the realization of a balance between supply and demand for U.S. debt is still full of uncertainty.

What worries the market even more is that such a huge debt scale also brings potential default risks. While the likelihood of a U.S. sovereign debt default as the world's largest economy and issuer of the U.S. dollar is extremely low, even a short-term technical default could trigger severe financial market disruptions.turmoil.

This is because U.S. Treasury bonds play a unique and critical role in the global financial system. It is not only the most important "safe asset" in the world, but also the benchmark for financial market pricing, and plays a core role in collateral guarantees, derivatives transactions, etc. Take the repo market as an example. U.S. debt is the main collateral, supporting trillions of dollars in short-term financing every day. If U.S. debt defaults, the market could immediately come to a standstill.

In addition, U.S. debt is also the most important liquidity reserve for global financial institutions. Banks, insurance companies, pension funds and other institutions all hold large amounts of U.S. debt as a liquidity buffer. Once U.S. bond prices fluctuate violently or liquidity dries up, these institutions may be forced to sell off assets, triggering a chain reaction. Especially when global debt levels are generally high, violent fluctuations in the U.S. debt market may be transmitted to other markets through various channels, triggering a broader financial crisis.

Historically, the United States had a short-lived small-scale debt default due to technical reasons in 1979, and the impact at that time was quite significant - causing short-term Treasury yields to surge by 60 basis points, financing costs in the Treasury market continued to be under pressure in the following months. The current scale and degree of interconnection of the U.S. debt market are far greater than those of the past. Once a similar situation occurs, the impact will be even more far-reaching.

Therefore, ensuring the smooth operation of the U.S. debt market is not only related to the U.S.'s own financial situation, but also to global financial stability. This is also an important reason why all parties are so concerned about the imbalance between supply and demand of U.S. debt. Against this background, the United States, the Federal Reserve and major market participants all need to act cautiously, not only to control debt growth, but also to maintain market confidence and avoid violent fluctuations. At the same time, others also need to take precautions, appropriately diversify reserve assets, and enhance the resilience of the financial system.

This supply and demand game surrounding U.S. debt is not only related to the sustainability of U.S. finances, but also to the stability of the global financial system. As the size of U.S. debt continues to expand, market attention on this issue will only increase further.