MainStreet Macro: The Global Footprint of U.S. Debt

I began my career as a PhD economist in the housing market, or to be more precise the mortgage market. Back then, I thought the two most local things you could buy were a haircut and a house. 

Well, I got it half right. While haircuts will always be local, how homes are financed in America is definitely not. 

People look to the Federal Reserve for a read on interest rates, but it’s not the only entity that determines the cost of U.S. mortgages and other borrowing. Buyers and sellers of U.S. debt both here and around the world also play important roles.

Today, we look at the global footprint of the U.S. bond market and how it lands squarely on Main Street.

Foreign demand for U.S debt is high

The starting point in our global bond journey begins with investors overseas. The global bond market is massive, bigger even than equities, with $123.5 trillion in outstanding securities.

U.S. debt issuance makes up more than 38 percent of the global market, or about $47.2 trillion. Federal, state, and local governments, companies, and even homeowners contribute to the nation’s bond issuance. 

While most of this debt is held domestically, roughly 30 percent of it is held by foreign investors, including other governments, central banks, private institutions, and individuals. 

U.S. Treasury data released last week showed that overseas investors increased their holdings in long-term U.S. securities for the third-straight month in January. Foreigners purchased nearly $74.4 billion in treasurys in January, up from $44.2 billion in December and the largest monthly investment since March 2021.

Foreign demand helps keep interest rates low

Foreign investment serves as a counterbalance to Federal Reserve rate increases, like the one the central bank announced last week as part of its effort to rein in inflation.

In their enthusiasm for U.S. debt, overseas investors accept lower returns, which keeps downward pressure on interest rates.

And that’s what makes today’s market so fascinating. Bond yields – thus returns – aren’t rising as much as inflation, meaning bonds aren’t as profitable as they’ve been in the past. There are other features, too, that make long-term U.S. bonds attractive overseas. Treasurys are highly liquid, meaning they’re easy to buy and sell. They are also low-risk, backed by the full faith and credit of the U.S. government.

And while U.S. yields are still hovering near historic lows, they still pay better than the debt of other advanced economies. That means investors continue to buy U.S. bonds even though they don’t offer big returns.

The global footprint at home

As the Fed hikes rates, there’s a lot of talk about what it means for mortgage rates.

Yes, mortgage rates have gone up, which they tend to do when the economy is growing rapidly.  But keep in mind the historical perspective.

The last time inflation was this high, mortgage rates soared to more than 15 percent. A typical 30-year, fixed-rate home loan now is about 4 percent.

One reason for the disconnect is that foreign investors don’t buy just Treasurys. They also buy U.S. home loans. In 2021, overseas investors sank $22.6 billion into U.S. mortgage securities, sending global capital straight to Main Street’s front door. 

My Take

The Fed has a three-point plan for bringing down inflation.

One, establish credibility. The central bank needs to convince Main Street and Wall Street that it has the policy chops to tamp down inflation in what Chair Jerome Powell calls this “highly uncertain” economic environment.

Two, raise the federal funds rate to just above 2 percent. Fed rate hikes are intended to cool an overheated economy by curbing enthusiasm for borrowing and spending. This is hard to do without cooling the economy too much. The good news is the Fed has shown skill in the past using measured rate hikes to thread the needle between growth and inflation.

Three, sell some of its own holdings. The Fed holds some $9 trillion in bonds that it bought to stimulate the economy after the 2008 recession and, more recently, during the coronavirus pandemic. This tactic will be trickier, because the Fed has never done it before, certainly never at this scale.

As the Fed exits its easy-money bond-buying spree, there are plenty of willing buyers for those U.S. securities, many of them overseas.

So while borrowing costs might inch up for Main Street, they’ll likely remain low because of the tremendous demand – both foreign and domestic – for low-risk U.S. debt.

As we’ve discussed a lot lately, Main Street is part of a global economy. Even the hyper-local act of buying a house is, at some level, a global transaction.