China & Japan Are Dumping US Bonds
In a Nutshell
China and Japan are selling hundreds of billions in US Treasuries, driving 30-year yields above 5% and creating a trap where the Federal Reserve cannot cut rates without breaking the bond market. Foreign selling, 6% PPI inflation, and $39 trillion in US debt force higher yields, which increases government interest costs above $1 trillion annually and risks triggering money printing. The stock market's record valuations and expectation of bailouts are misaligned with a Fed that may need to raise rates instead.
These notes were generated by AI and may contain inaccuracies.
A global sovereign debt crisis is underway as countries sell US debt. The bond market serves as the backbone of all markets. Yields are reaching the highest levels in decades while the stock market continues rallying. Investors stop trusting governments to pay back borrowed money and demand higher interest rates, which worsens the problem. The US 30-year Treasury bond yield has exceeded 5%, the highest level since July 2007. The 10-year bond yield has risen 75 basis points since the Iran war began.
Chris Waller, previously supportive of rate cuts, now states he is prepared to vote for rate increases if the war continues and inflation does not decline. He stated: "I can no longer rule out rate hikes further down the road if inflation does not abate soon. And that is especially true if measures of inflation expectations, some of which have risen lately, show signs of becoming unanchored." The market now predicts a rate increase by January 2027 with over 70% odds that interest rates will rise. A year earlier, Wall Street expected the Federal Reserve to cut rates three to five times.
China and Japan, two of America's largest foreign buyers of debt, are now selling US government debt. Additional countries selling include Taiwan, Saudi Arabia, India, the UAE, Norway, and Singapore. Oil has remained above $100 per barrel for approximately two months. The PPI inflation measure reached 6%, the highest level since 2023. CPI has returned to 3.8%, well above the 2% target.
The combination of factors creates a trap where the Federal Reserve cannot lower interest rates without breaking the bond market. A broken bond market would raise mortgage rates, credit card interest rates, and the cost of all loans including student and business loans. It would also impair the US government's ability to fund Social Security, Medicare, and the military without raising taxes or printing money. Bond yields are hitting multi-decade highs in the UK, Germany, France, Canada, Australia, and Italy.
Japan's 10-year bond yield has risen almost vertically on a 20-year chart. The Bank of Japan is losing control of its bond market. When Japan loses control, it must sell US Treasuries to defend the yen, which increases pressure on US bond yields and worsens the Federal Reserve trap. The global bond market totals $140 trillion.
Sovereign debt refers to government debt. Governments borrow by selling bonds, which function as IOUs. The US government promises to return borrowed money plus interest after 10 or 30 years. Bond yields are not set by the government but by buyers including foreign countries, private investors, and pension funds. When investors trust a government's repayment ability, they accept lower yields. When nervous about repayment or inflation, they demand higher yields.
A sovereign debt crisis occurs when investor nervousness reaches a tipping point and governments must pay so much yield that they can barely afford to borrow. When borrowing becomes unaffordable, governments cannot pay bills and must either raise taxes, cut spending, or print money. Historically, governments choose to print money because it is the least visible option. Treasury yields form the foundation for all other interest rates in the economy. The 30-year Treasury reaching its highest level since 2007 indicates the market's trust in the US government's debt management is at its lowest point in roughly 20 years.
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Investors demand higher yields due to inflation, reduced lending from major foreign buyers, and unsustainable government debt mathematics. Since the Iran war began, oil has exceeded $100 per barrel. Crude oil is up 60%, jet fuel up 58%, gasoline up 52%, European natural gas up 54%, and fertilizer up 20%. PPI reached 6% and CPI reached 3.8%.
Oil price increases do not directly translate into equivalent PPI increases because oil costs filter through supply chains and become diluted across labor, rent, and equipment. Fertilizer prices rising 20% will appear in grocery bills with a 3-to-6-month delay. The current 6% PPI reading represents an early warning, with the full commodity price effect still working through the system.
Lending money at 4.5% for 10 years while inflation sits at 3.8% and rising produces barely positive real returns. Investors also question official inflation figures and consider 10-to-30-year time horizons. With $39 trillion in US debt, investors perceive significant risk and demand higher interest rates.
China previously held $1.3 trillion in US Treasury bonds and now holds $650 billion, the lowest level since 2008. This represents a 17-year trend of gradual reduction rather than panic selling. Each sale removes a buyer from the market, requiring the US to offer higher yields to attract replacement buyers.
Japan holds approximately $1.1 trillion in US Treasuries and has sold over $200 billion since 2022 to defend the yen and purchase oil. In the first quarter of 2026, Japan sold more US Treasuries than in the previous four years combined. Selling Treasuries pushes US yields higher, strengthening the dollar relative to the yen and requiring Japan to sell additional Treasuries. This creates a doom loop.
Japan's GDP remains at approximately the same level as 1992 while its money supply has tripled over 34 years. Japan carries a 260% debt-to-GDP ratio compared to the US at roughly 120%. Raising interest rates would dramatically increase Japan's interest payments on its already unsustainable debt load. Japan's 10-year bond yield has risen sharply as a result.
With China and Japan reducing purchases, new buyers must come from American pension funds, market funds, and eventually the Federal Reserve itself.
The US government holds $39 trillion in official debt and adds approximately $2.5 trillion annually. Half of all tax revenue now goes toward servicing new debt before any spending on the military, Social Security, or infrastructure. Additional tens of trillions in unfunded promises exist for Medicare, Medicaid, Social Security, and pensions beyond the $39 trillion figure.
In 1970, the US government faced similar impossible mathematics and chose to inflate its way out rather than raise taxes or cut benefits. The purchasing power of the US dollar dropped approximately 50% between 1970 and 1980. Gold rose from $35 per ounce to $850 per ounce during that decade. Bond investors now anticipate similar future money printing and demand higher yields to compensate.
The stock market remains at all-time highs partly because it prices in the expectation that the Federal Reserve will print money during a crisis, which would drive asset prices higher.
Normally, the Federal Reserve lowers rates during economic slowdowns to stimulate borrowing and spending. Currently, cutting rates while PPI sits at 6%, CPI at 3.8%, and oil above $100 would signal to bond investors that the Fed prioritizes the economy over protecting purchasing power. Bond investors would sell, causing yields to rise despite the rate cut. This is the trap of attempting to lower rates during rising inflation.
Raising rates or holding them steady increases the US government's annual interest expense, which has already exceeded $1 trillion per year. Credit card delinquencies exceed 12%, auto loan defaults are rising, private credit markets face risk, and the housing market has slowed significantly. Stock market valuations remain elevated.
The stock market predicts a rate increase by January 2027 with over 70% probability. The market indicates the Federal Reserve has lost control and must raise rates to maintain demand for US debt. Kevin Worsh, selected by Trump as the new Fed chair specifically to lower rates, now faces this impossible situation.
The Federal Reserve under Kevin Worsh proposes shifting from standard core PCE to trimmed mean PCE. This metric excludes extreme price increases such as the 60% rise in oil prices, producing a lower official inflation number on paper.
The stock market continues performing well because it assumes that when conditions deteriorate sufficiently, the Federal Reserve will print money and bail out asset prices.
The stock market is betting on eventual bailouts, a wager that has historically been correct. However, the Fed cannot print money as easily this time without breaking the bond market. The stock market may be pricing in an outcome that will not occur. Current valuations appear expensive across multiple metrics. The price to sales ratio is at a record high. The price to book ratio is also at a record high. The forward price to earnings ratio sits at approximately 24 times, which is historically very high. The dividend yield is near a record low at 1%. Investors are paying maximum prices for minimum income.
This combination is problematic when the risk-free rate from government bonds exceeds 5% and may rise further. A stock paying 1% in dividends becomes difficult to justify versus a Treasury bond paying 5% with essentially no risk. The only rationale for holding stocks would be an expectation of growth exceeding that 5% threshold, despite already elevated valuations.
The Buffett indicator, adjusted by Luke Groman's FFTT methodology, measures total market cap divided by GDP, then adjusted for federal debt used to artificially boost the figure. Over the past 70 years, this adjusted indicator has exceeded 100% on exactly three occasions: the peak of the dot-com bubble in 2000, the everything bubble peak in late 2021, and the present moment. In both prior instances, the market declined between 25% and 47% from peak to bottom, requiring between 2 and 13 years to recover.
Traditional financial theory suggests rising rates should pressure gold prices, as higher interest rates favor holding cash or bonds over non-yielding assets. A period of outflows from gold into interest-bearing instruments remains possible. Gold prices are currently elevated due to central bank purchases exceeding one thousand tons in 2024 alone. Central banks appear to be choosing gold over Treasury bonds despite being less sensitive to interest rates than individual investors. These institutions typically possess advance information and may be positioning for geopolitical diversification toward a potential gold-backed world reserve currency.
Bitcoin operates on the premise that widespread government money printing will erode currency purchasing power. Its fixed supply offers protection against inflation or asset freezes by any government. Iran has begun demanding Bitcoin for oil sales, serving as confirmation that sovereign actors seek this form of insurance against traditional financial systems.
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