U.S. bonds fluctuate and shake the foundation of the hegemony of the US dollar (economic perspective)

Source: People's Daily

Recently, the United States' wanton implementation of tariff policies has directly impacted the international financial market, and a rare phenomenon of the simultaneous decline of the U.S. stock market, bond market, and foreign exchange market has occurred. Among them, the yield on the 10-year U.S. Treasury bond rose from 4.01% on April 4th to 4.49% on April 11th, hitting the largest single-week increase since the September 11 attacks in 2001. The soaring yield corresponds to a significant decline in the price of U.S. Treasury bonds, which has in turn triggered widespread concerns around the world about the systemic risks of the U.S. Treasury bond market.

Since April, the rapid rise in the yield of U.S. long-term Treasury bonds and the resulting huge market fluctuations have been mainly driven by four factors:

First, the U.S. government's wanton implementation of tariffs has triggered expectations of reflation in the U.S. economy. The market predicts that just the move of increasing U.S. tariffs on Chinese goods to 245% will significantly push up the prices of its imported goods, deteriorate the living standards of the low- and middle-income groups in the United States, and boost its future inflation expectations. The increase in inflation expectations has led to a narrowing of the room for the Federal Reserve to cut interest rates, which in turn has pushed up the yields of long-term Treasury bonds.

Second, the willingness of foreign investors to purchase U.S. Treasury bonds has further declined. Against the backdrop of intensified geopolitical games, the scale of European institutional investors' investment in U.S. dollar assets has significantly decreased recently. At the same time, the U.S. dollar index has depreciated significantly. Market concerns about the sustainability of the U.S. fiscal deficit and the expectation of the continued rise of U.S. long-term interest rates have all reduced the willingness of foreign investors to continue buying U.S. Treasury bonds in the short term, which will also push up the yields of U.S. long-term Treasury bonds.

Third, the unilateral soaring of U.S. Treasury bond yields has led to the rapid closing of positions in Treasury bond basis trading. In the past, there were a large number of arbitrage transactions between U.S. Treasury bond spot and futures in the U.S. Treasury bond market that were magnified through leverage. Now, with the significant increase in the yields of U.S. long-term Treasury bonds and the sharp drop in the prices of Treasury bond spot, arbitrageurs engaged in basis trading are forced to close their positions to stop losses, resulting in a large-scale sale of Treasury bonds, further driving up the interest rates of long-term Treasury bonds.

Fourth, the reputation of U.S. Treasury bonds as a global safe asset has been severely weakened. Stephen Milan, Chairman of the White House Council of Economic Advisers, recently proposed in a report that in the future, foreign investors should be "forced" to replace their U.S. Treasury bonds with ultra-long-term low-interest bonds, and investors should be restricted from directly selling these U.S. Treasury bonds in the market. If foreign investors refuse to "cooperate," the U.S. government will impose high taxes on the investment returns of these investors. Such acts of financial bullying will seriously erode the reputation and credit of U.S. Treasury bonds. Under the influence of relevant expectations, the current willingness of foreign sovereign investors to purchase U.S. Treasury bonds has significantly declined, which will also lead to an increase in the yields of U.S. Treasury bonds.

Overall, fundamental factors, market supply and demand factors, the closing of arbitrage trading positions, and asset reputation factors have jointly pushed up the interest rates of U.S. long-term Treasury bonds, and there is no exclusion of the possibility that the yields of U.S. long-term Treasury bonds will continue to rise significantly in the coming months. This will undoubtedly bring more risks to the United States itself.

The rise in bond interest rates will significantly increase the pressure on the U.S. government to repay principal and interest, further exacerbating the fiscal deficit. As a large number of U.S. Treasury bonds mature within the year, the U.S. government will issue new Treasury bonds, and the cost of issuing Treasury bonds at present is undoubtedly much higher than in the past. This means that in the coming period, the pressure on the U.S. government to repay principal and interest will increase significantly, and it will continue to trigger market concerns about the sustainability of U.S. debt. The serious decline in the credit of U.S. Treasury bonds will ultimately shake the foundation of the U.S. dollar hegemony. Conversely, global investors will have a stronger willingness to invest in other safe assets and will increasingly turn to other safe assets with sufficient liquidity, higher yields, and a large enough scale.

(The author is the Deputy Director of the Institute of Finance, Chinese Academy of Social Sciences)

Disclaimer: The views in this article only represent the personal views of the author and do not constitute investment advice on this platform. This platform makes no guarantees regarding the accuracy, completeness, originality, and timeliness of the article information, nor does it assume any liability for any losses caused by the use or reliance on the article information.