U.S. Treasury market faces rising funding risks

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U.S. Treasury funding risks

Highlights

Foreign official demand for the $30tn U.S. Treasury market is weakening as issuance stays high, with 30-year yields reaching 5 per cent last month for the first time since 2007.
Hedge funds and other short-term, leveraged investors have grown their market share over the past five years, amplifying volatility and funding risks during periods of market stress.
Regulatory reforms like mandatory central clearing and possible capital rule adjustments may aid liquidity, but persistent large deficits and policy uncertainty are expected to sustain upward pressure on yields.

Demand shifts and market structure strains

As reported by Financial Times, the roughly $30tn U.S. Treasury market is coming under pressure as traditional sources of demand weaken while debt issuance stays elevated. The benchmark 10-year yield has largely remained above 4 per cent in recent years, and a new 30-year issue priced at a 5 per cent yield last month for the first time since 2007.

In the early 2000s, central banks, particularly in export-led Asian economies, absorbed large volumes of Treasuries, helping the U.S. finance deficits at relatively low rates. That dynamic has faded as foreign official buying no longer keeps pace with issuance, partly because of reserve use by China and partly because sanctions risk is encouraging diversification into assets such as gold.

A separate shift in the buyer base is also adding volatility. Hedge funds and other shorter-term investors have expanded their share of the market over the past five years, and their use of borrowed money to exploit small pricing gaps can amplify swings during periods of stress.

Reform options and borrowing-cost implications

Regulatory and market-plumbing changes could help stabilise trading conditions and support liquidity. New Securities and Exchange Commission rules for mandatory central clearing in Treasuries are intended to reduce counterparty risk, while some banks argue that post-crisis capital rules should be adjusted so they can hold more U.S. government debt.

A growing stablecoin market could add another source of Treasury demand, although poor oversight could also create fresh vulnerabilities. The Federal Reserve under new chair Kevin Warsh could also address fragility through emergency tools, but his preference for quantitative tightening and reduced forward guidance may point to higher borrowing costs rather than relief.

Broader risks remain tied to fiscal and policy choices in Washington. Regulatory reform may support confidence, but continued large deficits and unpredictable policymaking are still likely to keep upward pressure on yields and increase the risk of more volatile market reactions.

In our earlier article on Kevin Warsh’s shift toward less Fed forward guidance, we examined how his shorter, less prescriptive policy messaging could increase uncertainty about the future path of interest rates and make market reactions more volatile. We also highlighted unresolved questions around how Warsh will assess restrictiveness, interpret economic data, and manage balance-sheet policy—factors that can directly influence financial conditions and, ultimately, Treasury yields.

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