The Shifting Composition of Treasury Buyers Threatens to Worsen the U.S. Debt Trajectory

Investors are demanding greater returns to hold U.S. government debt. Notwithstanding the Treasury’s pledge to buy back more long-term securities, 30-year Treasuries recently sold at their lowest price in nearly 20 years.

The fundamental problem, as we show in the graphic above, is that the issuance of Treasuries necessary to cover the government’s burgeoning debt is outpacing the appetite of price-insensitive buyers, such as foreign central banks. The upshot is that Treasuries must increasingly be absorbed by price-sensitive buyers, such as households and investment funds, who react to ongoing fiscal indiscipline and inflationary pressures by demanding higher and higher interest rates for holding long-term debt.

This phenomenon will only be exacerbated by new Fed Chair Kevin Warsh’s agenda of reducing the central bank’s balance sheet through quantitative tightening (QT). As the graphic shows, between 2017 and 2019––the first time the Fed actively reduced its balance sheet––price-sensitive investors’ share of Treasury holdings increased by 8 percentage points. Still, the estimated 10-year term premium—the extra compensation demanded by investors to hold long-term debt¹—did not rise during “QT1.”

During “QT2,” from 2022 to 2025, however, the price-sensitive share rose by a much larger 17 points, and the term premium rose by 1.1 percentage points. That vast difference between the two episodes is explained by two main factors. First, QT2 was much larger—pushing about 4 times as many Treasuries into the market ($1.6 trillion). Second, U.S. debt levels were increasing at a far more rapid rate. In QT1’s 22 months, debt grew 8 percent, from $20.5 trillion to $22.7 trillion. Over the first 22 months of QT2, debt grew 12 percent, and by the time it concluded, 21 percent––ending the period at $38.5 trillion.

If the term premium responds proportionally to the price-sensitive share, then it should also have risen slightly in QT1, as it did in QT2. One explanation for this discrepancy is that heavier Treasury issuance and a larger balance-sheet runoff pushed more Treasuries into the market at once, causing a faster increase in the price-sensitive share in QT2. That is, with the gap between supply and price-insensitive demand wider than in QT1, higher compensation was required to attract new price-sensitive buyers, raising the term premium. QT, then, needs to be scaled against Treasury issuance from rising debt levels to avoid raising the term premium.

Against the present background of historically loose fiscal policy—with an expected deficit-to-GDP ratio of 5.8 percent this year—“QT3” could further increase the dominance of price-sensitive Treasury buyers. The combination of fiscal profligacy and Fed balance-sheet reduction will therefore require even more price-sensitive investor participation—meaning higher interest rates on government debt, and a worsening spiral of upward issuance and higher borrowing rates across the economy.

To be sure, there is no more appropriate preventative for a potential debt crisis than a belated embrace of fiscal discipline. Still, Warsh should avoid pouring fuel on the fiscal fire by shelving his balance-sheet ambitions. If the Fed inadvertently overshoots on security sales, repo and federal-funds rates can jump abruptly—as they did in September 2019. The Fed would then have to reverse course with emergency liquidity injections, undermining the long-standing ambition of making policy more predictable.