Nobody is saying that foreigners will abandon Treasuries altogether. After all, they still hold $5.94 trillion, or roughly 43% of the U.S. government debt market. (Though that's down from 56% in 2008.) A significant drawdown can harm major holders like Japan and China as much as it does the U.S.

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

Lasting Consequences

Nevertheless, any consistent drop-off in foreign demand could have lasting consequences on America's ability to finance itself cheaply, particularly in light of Trump's ambitious plans to boost infrastructure spending, cut taxes and put “America First.” The president has singled out Japan and China, the two biggest overseas creditors, as well as Germany, for devaluing their currencies to gain an unfair advantage in trade.

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

For now, risk-averse bond buyers like Daiwa SB Investments's Shinji Kunibe are cutting back on Treasuries, despite some clear advantages.

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

However, Kunibe sees U.S. yields rising further as Trump pursues expansionary fiscal policies and takes a protectionist stance on trade.

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

Big Losses

And investors like Kunibe can ill afford more losses. Last quarter, Japanese investors who hedged all their dollar exposure in Treasuries suffered a 4.7% loss — the biggest in at least three decades, data from Bank of America showed. The same thing happened in Europe, where record currency-hedged losses also stung euro-based buyers.

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

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

What's more, central bankers in Japan and Europe are still experimenting with monetary policies that may benefit bond investors 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. rates strategy.

Bloomberg News

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