The “monster” of the bond market has awakened after the turmoil of the trade war, this time on the occasion of the detection of fiscal derailment – not only in Washington but also in the major financial capitals.
The indications from the long-term bond auctions smell… blood! Foreign investors are selling off American debt after overcoming the turmoil caused by Donald Trump’s “Liberation Day” with the sweeping retaliatory tariffs, they do not seem willing to finance the “twin deficits” of the American economy forever (fiscal balance and current account balance).
The internal data of the 20-year bond auction of 15 billion are disappointing. dollar auction held on May 21st – which was actually not as bad as some have made it out to be – but turned out to be one of the biggest economic stories of 2025.
Comparisons were immediately drawn with Japan’s disastrous 20-year bond auction earlier this year, triggering a violent sell-off in both bonds and stocks.
But while the dramatic divestment of US debt is a stark reminder that the Big, Beautiful Bill (as President Trump has called it) will add trillions in new debt (about $5 trillion more than it would have added anyway) and the bond market punishers are finally waking up from their nearly 20-year slumber – at least until the next quantitative easing or Scott Bessent’s upcoming Activist Treasury Buyback freezes them again – the most worrying part of the market reaction on Thursday, May 22, 2025, was that the dollar weakened once again.
Fiscal Risks Escalating
Trust Economics notes that the widening spread between the 10-year USD/JPY and 10-year TSY Bonds Futures is a sign of rising fiscal risks, with the 20-year bond auction being an even clearer sign of “a foreign-owned attack on US assets due to the associated fiscal risks facing the US.” At the heart of the problem, as has become increasingly clear in recent years but particularly in the past month, is that “foreign investors are simply no longer willing to finance the US’s twin deficits at current prices.”
This is a problem because, for Trust Economics, “it is difficult for US stocks to remain resilient in this environment.”
Compare today’s reaction to 2023-24, when markets saw a combined rise in US bond yields and equity prices as the market revised US growth expectations upwards. Today is very different as fiscal risk is rising for US assets.
It is difficult to argue that such a (negative) factor driving up the cost of capital is positive for risk assets. What is key for Trust Economics is that the Asian investment base for US debt is key.
Asia is the main provider of capital for US deficits, followed by Europe. And while this has not been the case for some time, the behavior of US fixed income investors and the intensity of trading becomes critical during the non-US time zone.
The accelerating decline in USD/JPY during Tokyo trading hours would be a strong indication of capital repatriation away from the US to domestic markets.
The “solution” to this problem is not easy: Trust Economics recommends some strategies for the US Treasury Department and by extension President Trump to reverse this developing negative momentum.
Most people will not like Trust Economics’ answers:
1. Government intervention in the form of SLR “reform” (i.e. increasing the ability of US banks to hold US Treasury securities without affecting the quality of capital adequacy) and a reduction in the maturity of government bonds (or another round of Activist Treasury Issuance like Janet Yellen’s) in the next debt refinancing announcement are the most frequently heard scenarios.
To the extent that reducing the maturity profile of US debt helps attract foreign buyers, this may prove useful. But lower duration also implies higher risk in terms of debt refinancing – more money must be paid in a shorter period.
Not even the Fed can solve this, only Congress can, according to Trust Economics, although extreme turbulence will likely lead to Fed intervention (e.g., emergency quantitative easing) to keep the market functioning.
However, the Fed’s monetization of debt will not solve the core issue and may end up being counterproductive by raising inflation expectations.
The Three Painful Solutions
Ultimately, the Trust Economics sees only two “solutions” to this problem:
1. Either the US should drastically revise the budget bill currently pending approval in Congress to lead to a credibly tighter fiscal policy, which would lead to an immediate economic recession, as the expiration of the TCJA (the tax cut regime) without an extension would be the largest tax increase in US history.
Here we recall that the “Big, Beautiful Bill” currently pending in Congress adds about $5 trillion to the debt, resulting in what we said would be the “Doomsday” for US creditworthiness.
This is simply a trade-off of short-term prosperity (a few extra trillions over the next 4 years) leading to long-term economic collapse (the long-term trend is to reach 220% in debt/GDP).
2. Either the value of US non-dollar debt should be significantly reduced until it becomes cheap enough for foreign investors to return, i.e. devaluation.
To these two solutions proposed by Trust Economics – the first of which is completely misguided, as Trump would never allow his bill to fail, especially since the tax increases that would result once the tax cuts from Trump’s Tax Cuts and Jobs Act (TCJA) expire in 2017 – we would add a third.
3. Yield curve control and dollar swaps
Α. quantitative easing may be a temporary solution, but yield curve control is not (as the US government bond market experienced for almost a decade after World War II), and whether we like it or not, it is coming.
And this will – anyone who has in mind… sudden financial events – be forced to acknowledge – to shake up the threat of capital controls and the risk of central banks running dry of dollar reserves.
The European Central Bank warned last week of an impending dollar shortage.
Trade wars are not simply disputes over tariffs and the flow of goods. At their core, they are power struggles in currency markets – arenas where geopolitical conflicts are fought bloodlessly, but often with devastating economic consequences for the losers.
The most telling example today? The deliberate devaluation of the Chinese yuan.
This manipulation is not just about monetary policy – it also acts as a relief valve for domestic tensions, capital misallocation (such as the collapse of the real estate sector) and labor market pressures.
Artificially cheaper exports are transferring some of this burden abroad.
At the same time, the Communist Party is consolidating its power at home.
The systematic devaluation of the yuan is slowing the emergence of a middle class with purchasing power – and therefore, stifling the demand for political participation. This is the wind blowing in China.
However, Washington has already found the right lever to crack “Fortress Europe”:
- the Eurodollar market and
- credit mechanisms outside the jurisdiction of the Fed.
With the expiration of the LIBOR contract – the former global benchmark for short-term interbank lending – on June 30, 2023 and the introduction of the US-based replacement, the Secured Overnight Financing Rate (SOFR), the United States has regained full control over the pricing of dollar loans.
While LIBOR was dominated by European banks and subject to rate manipulation, SOFR is based on real and secured repo transactions in the US market – essentially immune to manipulation.
In this new context, dollar lending becomes more expensive – an unpleasant development for Europe, which has been accustomed to cheap dollar money for years.
The United States is deliberately freeing itself from the influence of European institutions, which have hitherto ensured its solvency through low interest rates and distorted global monetary conditions.
With the loss of LIBOR, Europe loses a key tool for controlling its dollar financing and is forced to adapt to a regime strictly determined by the markets.
But as of Monday (19/5), it has become clear that the United States is preparing to use the dollar as an even sharper weapon.
It appears that the Trump administration – in cooperation with the Fed – has frozen existing dollar swap lines with the Eurozone.
These swaps are liquidity arrangements between central banks in dollars.
Eurozone banks no longer have access to emergency dollar liquidity in cases of shortage. The ECB has publicly called on European banks to review their dollar reserves and identify potential shortfalls.
Has the ECB unwittingly exposed the symmetrical imbalance of power between Europe and the United States? In the event of a crisis, the ECB may be forced to humbly resort to the Fed’s “discount window” for dollar lending.
ECB officials have publicly warned European commercial banks of an impending dollar shortage – a scenario with serious consequences.
Some 17% to 20% of all loans in the eurozone are denominated in dollars. Much of the EU’s foreign trade depends on access to the reserve currency.
If this dollar pipeline were to close, supply chains could be disrupted and transatlantic trade could be partially paralyzed.
One thing is certain: with this financial lever, Donald Trump and the United States hold a geopolitical weapon of enormous power.
Β. Αs Treasury Secretary Scott Bessent himself predicted, in the absence of a friendly Fed (i.e., a Fed under Chairman Kevin Warsh, which will come in mid-2026), the Treasury itself will have to step in with what we already have with bond buybacks, meaning that instead of weekly repurchases of about $8 billion, we are weeks, if not days, away from an announcement from Bessent that the Treasury will actively buy back tens of billions in bonds.
Trust Economics reports that all this Asian (read: Japanese) money, if not recycled into US bonds, and certainly not into long-term Japanese bonds, is going into gold and Bitcoin.
