These growing debt pressures are unfolding against the backdrop of global de dollarization and declining demand for US debt from traditional buyers (such as China and Japan). To understand how US debt enters and flows through the financial system, consider the following process:
The US Treasury Department determines the issuance schedule, amount and securities type according to the government’s financing needs, and chooses to raise capital through short-term instruments (such as treasury bills and short-term treasury bond bonds) or long-term bonds (such as 10-year and 30-year treasury bond).
These securities are issued through Dutch style auctions, and all successful bidders receive the same rate of return. The main market participants include large banks and financial institutions, the Federal Reserve, domestic investment funds (such as pension and mutual funds), individual investors (directly or through brokers), as well as foreign governments and central banks.
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After the issuance of securities, the Ministry of Finance records the official holders, who may be the ultimate investors, brokers, or clearing houses.
Debt is subsequently traded in the secondary market, similar to stocks, and bond prices fluctuate based on supply and demand. The Ministry of Finance regularly (usually every six months) pays interest to bondholders.
When existing debt matures, the Ministry of Finance typically issues new debt to refinance the principal – a process commonly referred to as’ debt monetization ‘.
Demand for US treasury bond bonds
Since World War II, US government debt has been a cornerstone safe haven asset in global financial markets, with Treasury bills commonly referred to as “risk-free rates”. Historically, the demand for US debt has been strong, driven by domestic investors and foreign central banks and governments. However, over the past decade, traditional buyers – including the Federal Reserve, major US banks, and foreign sovereign investors – have steadily reduced their purchases. Instead, relative value hedge funds registered mainly in tax preference jurisdictions such as the United Kingdom, the Cayman Islands and Luxembourg have become the leading players in the treasury bond market. These funds have played an important role in curbing the yield of U.S. government debt. This trend was clearly pointed out in the quarterly refinancing announcement of treasury bond bonds that they are marginal buyers who maintain the yield ceiling. However, this dynamic is becoming increasingly fragile. The rise in repo rates and tightening of margin requirements are beginning to limit the ability of hedge funds to maintain these positions. If these pressures continue, they will pose an increasing risk to the stability of the treasury bond market.