In the age of Trump, America's biggest foreign creditors aresuddenly having second thoughts about financing the U.S.government.

In Japan, the largest holder of Treasuries, investors culledtheir stakes in December by the most in almost four years, theMinistry of Finance's most recent figures show. What's striking isthe selling has persisted at a time when going abroad has rarelybeen so attractive. And it's not just the Japanese. Across theworld, foreigners are pulling back from U.S. debt like neverbefore.

From Tokyo to Beijing and London, the consensus is clear: fewoverseas investors want to step into the $13.9 trillion U.S.Treasury market right now. Whether it's the prospect of biggerdeficits and more inflation under President Donald Trump or higherinterest rates from the Federal Reserve, the world's safest debtmarket seems less of a sure thing — particularly after the upswingin yields since November. And then there is Trump's penchant forsaber rattling, which has made staying home that much easier.

“It may be more difficult than usual for Japanese to invest inTreasuries and the dollar this year because of politicaluncertainty,” said Kenta Inoue, chief strategist for overseas bondinvestments at Mitsubishi UFJ Morgan Stanley Securities in Tokyo.“Treasury yields may rise rapidly again in the near future, whichwill continue to discourage them from buying aggressively.”

Nobody is saying that foreigners will abandon Treasuriesaltogether. After all, they still hold $5.94 trillion, or roughly43% of the U.S. government debt market. (Though that's down from56% in 2008.) A significant drawdown can harm major holders likeJapan and China as much as it does the U.S.

And, of course, homegrown demand has of late been able to absorbthe pickup in overseas selling. Since reaching 2.64% inmid-December, yields on benchmark 10-year notes have come backand are essentially flat this year. They were at 2.43%Monday.

Lasting Consequences

Nevertheless, any consistent drop-off in foreign demand couldhave lasting consequences on America's ability to finance itselfcheaply, particularly in light of Trump's ambitious plans to boostinfrastructure spending, cut taxes and put “America First.” Thepresident has singled out Japan and China, the two biggest overseascreditors, as well as Germany, for devaluing their currencies togain an unfair advantage in trade.

In December, Japanese investors reduced their investments inU.S. debt by 2.39 trillion yen ($21.3 billion) after a smallerpullback in November. While only a fraction of Japan's $1.1trillion of holdings, they were the first back-to-back declinessince the start of 2014. China, which owns just over $1 trillion ofTreasuries, has been selling since May. Its holdings are at aseven-year low.

For now, risk-averse bond buyers like Daiwa SBInvestments's Shinji Kunibe are cutting back on Treasuries, despitesome clear advantages.

Like many institutional money managers that invest abroad,Kunibe, Daiwa SB's head of fixed-income management, likes to hedgeaway the risk of the dollar's ups and downs. And right now, itmakes sense. After accounting for hedging costs, 10-year Treasuriesyield about 0.9%, roughly 10 times the return offered byJapanese government bonds. Going back to the 1980s, Treasuries haverarely enjoyed such a big edge over JGBs.

However, Kunibe sees U.S. yields rising further as Trump pursuesexpansionary fiscal policies and takes a protectionist stance ontrade.

“Yields are going to be in an uptrend,” he said.

Big Losses

And investors like Kunibe can ill afford more losses. Lastquarter, Japanese investors who hedged all their dollarexposure in Treasuries suffered a 4.7% loss — the biggest inat least three decades, data from Bank of America showed. The samething happened in Europe, where record currency-hedged losses alsostung euro-based buyers.

“It was a deer in the headlights moment,” said Zoltan Pozsar, aresearch analyst at Credit Suisse.

Combined with the unpredictability of Trump's tweet storms,interest-rate increases in the U.S. could further sap overseasdemand. Mark Dowding, who helps oversees about $50 billion asco-head of investment-grade debt at BlueBay Asset Management inLondon, says the firm has already moved to insulate itself fromfurther losses due to higher rates.

What's more, central bankers in Japan and Europe are stillexperimenting with monetary policies that may benefit bondinvestors locally.

Right now, it's just “much easier to stay home than go abroad,”said Shyam Rajan, Bank of America's head of U.S. ratesstrategy.

Bloomberg News

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