A trillion dollars a year in net new demand for US Treasury securities requires substantial participation by three main sectors: US financial institutions, households, and foreigners (unless of course the Fed were to return to QE).

The last data we have for Treasury holdings from Flow of Funds stops with 2018:Q1. During most years, foreign governments and investors were the biggest net purchaser of Treasuries, although households dominated in 2008-2009 during the recession, and financial institutions made a substantial contribution during the year ending in the 1st quarter of 2018.

Contributions to increase in Treasury holdings

All three of these sectors are challenged:

  1. Households would have to shift from a dis-saving to a savings mode to make a substantial contribution to the trillion-dollar Treasury financing requirements. That would imply a significant decline in spending.
  2. Foreigners are having difficulty hedging the foreign exchange risk of Treasury purchases, and have already reduced their net purchases of Treasuries.
  3. Financial institutions are buying fewer Treasuries due to the flat yield curve.

Total foreign holdings of US Treasuries vs ‘major holders’

Bank holdings of treasuries, yoy change

It seems unlikely that foreign investors would dominate Treasury purchases given difficulties in FX hedging, so that leaves financial institutions and households.

In the case of financial institutions, a significant bearish steepening would be required to bring them back into the market.

If households make up the gap, we are in or close to a recession.