Allies, Anxiety, and America’s Debt
Earlier this year, a Bloomberg report, “Trump Agenda Needs Allies to Stick by U.S. Debt as Others Flee,” detailed how the U.S. is becoming increasingly dependent on allies as our debt burden swells. That report rings even more true today, as the U.S. pursues a controversial and costly war with Iran.
The U.S. budget deficit continues to grow—from $1.8 trillion in 2025 to $1.9 trillion in 2026 and $2.2 trillion in 2027, according to projections by the Congressional Budget Office. On top of those projections, the Trump administration is reportedly seeking up to a $200 billion supplement to pay for the Iran war and another $450 billion increase in defense spending.
As of April 2026, the total amount of U.S. debt outstanding was nearly $39 trillion—composed of $31.4 trillion in public debt and $7.6 trillion in intragovernmental holdings, according to the Treasury Department. About 31% of the $39 trillion held by the public was owned by foreign investors, as of December 2025.
Last year, long-standing U.S. allies bought $464 billion of Treasuries, the biggest annual total since 2016. At the same time, hostile (or less friendly) countries sold over $125 billion of Treasuries, marking the biggest offload in six years (Figure 1). For example, the U.K., Canada, and Japan were the largest buyers of Treasuries in 2025, while China, India, and Brazil were the biggest sellers (Figure 2).
Foreign ownership of Treasury securities also reached a record high of $9.49 trillion in February 2026, equal to approximately 31% of publicly held U.S. debt. China used to be the largest foreign holder of Treasuries, but its holdings have fallen consistently, from $1.3 trillion in 2017 to less than $700 billion in 2026. Figure 3 shows the countries with the largest holdings of U.S. sovereign debt, as of February 2026.
At the end of 2025, about 42% of foreign holdings of federal debt were held by governmental sources, and the other 58% were held by private investors. Private investors include asset managers, insurance companies, banks, and other corporations domiciled abroad. (This explains why tiny countries like Luxembourg and the Cayman Islands are large holders of U.S. debt.)
U.S. allies were already weary of many policy shifts from the current administration, such as punishing tariffs, wavering support for NATO, lukewarm support for Ukraine, and sometimes chummy relations with Vladmir Putin. The surprise war with Iran and resulting energy crisis in Europe and Asia have spooked U.S. allies even more.
However, despite the risks and uncertainties posed by the Iran war, the S&P 500 was on a four-week winning streak through Friday and recently hit an all-time high. Meanwhile, Treasuries have languished. Defying their “safe haven” moniker, Treasury yields rose sharply after the war commenced, stoked largely by inflation expectations from rising costs of energy and other materials (such as helium, chemicals, and aluminum), as well as by a shifting federal funds rate outlook. The yield on the 10-year Treasury note is essentially flat, year over year, and about 35 basis points (bps) higher than before the war started.
But do foreign governments and other private investors really have a choice over whether to own U.S. debt? Treasuries are the most liquid debt investment in the world, hence their moniker as the benchmark from which all other debt is measured. “There just aren’t large alternatives to the U.S. market,” observed the head of one of Japan’s biggest investment funds. “Even if investors feel some frustration towards America, it’s not practical to shift capital somewhere else.”
However, there are signs that the U.S. benchmark is shining less brightly. For example, highly rated U.S. corporate debt (Walmart, Apple, Google, Microsoft, J&J, Wells Fargo, etc.) now trades at much tighter spreads to Treasuries with comparable maturities.
The extra yield above Treasuries that investors demand to hold investment grade, fixed-rate corporate debt has dropped by about half since 2022—indicating either more demand and an improving credit profile of U.S. companies and/or less demand and a worsening credit profile for Treasuries. The U.S. has been downgraded one notch from the triple A perch by all three major U.S. credit rating agencies (S&P in 2021, Fitch in 2023, Moody’s in 2025), but that alone cannot explain a halving of the credit spread.
The often-dysfunctional federal government, its widening deficit, and otherwise worsening credit profile provide an ongoing impetus for some investors to find alternatives to Treasuries. Consider China’s stated aim of diversifying away from Treasuries and its slow, cautious process of doing so. But will others follow China’s example? “The risk isn’t that China sells,” said a global macro investor. “That’s priced in. The risk is that allies stop buying or start hedging en masse.”
Warsh Your Worries Away
After Kevin Warsh’s appearance before the Senate Banking Committee last Tuesday, markets are pricing more than a 90% probability that Warsh will replace Jerome Powell as Chair of the Federal Reserve by August 1. Still, before last Friday, it seemed unlikely that Warsh would be Senate confirmed due to the ongoing Department of Justice investigation into cost overruns associated with the renovation of the Fed’s headquarters.
The committee is narrowly controlled by Republicans, who largely support Warsh’s nomination, with a 13–11 lead. However, one key Republican Senator, Thom Tillis, is a major roadblock—in a good way. Representative Tillis, who will retire after his current term ends, supports Warsh’s nomination but vowed to block his confirmation vote until the DOJ investigation is resolved.
Tillis won that battle after the DOJ announced last Friday that it would drop the probe into the renovations. “I have directed my office to close our investigation as the IG [Inspector General] undertakes this inquiry. Note well, however, that I will not hesitate to restart a criminal investigation should the facts warrant doing so,” announced Jeanine Pirro, U.S. Attorney for the District of Columbia. Hopefully this standoff is now resolved and the path for Warsh’s confirmation is much clearer.
Meantime, Warsh did his best to convince the committee not to worry about the Fed under his proposed leadership. Below, we offer some salient quotes from Warsh’s Senate hearing.
- On Fed independence: “I do not believe that independence of monetary policy is threatened when elected officials state their views on rates. Fed independence is up to the Fed.”
- On inflation: “The trajectory on inflation is improving, but there’s more work to do.”
- On his relationship with Trump: “The president never asked me to pre-determine, commit, fix, or
decide on any interest rate decision, in any of our discussions—nor would I agree to do so.” - On economics majors: “Economics is not physics. It’s not math. Frankly, most of us that ended up in the economics business, we started like I did as a math major. It [math] was too hard, so we ended up in economics. In economics, what we need to do is focus to the left of the decimal point, not to the right of the decimal point.” (A writer of this Talking Points concurs.)
FROM THE DESK
Agency CMBS — Fannie Mae origination volume was light last week, at only $510 million, and spreads compressed two to four bps, week over week. Ginnie Mae volume was also uninspiring, though we did trade eight new issue pools during the week. Ginnie spreads were flat to one bp tighter.
Municipals — AAA tax-exempt yields moved higher the first four years and were flat thereafter, week over week. The municipal bond market tone was mixed, with the front end under pressure while longer-term deals received more attention from investors. The weakness on the front end led to an inverted curve the first three years to end the week. We expect the weekly volume for primary new issuance to drop this week, given the Fed meeting on Wednesday. Investors put $1 billion into funds last week, bringing year-to-date inflows to $18.40 billion. High-yield funds received $111 million of the weekly inflow.
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