US Treasury yields face a foreign demand test as China and Japan cut exposure

The Treasury market’s next problem may be who buys the debt

The rise in U.S. Treasury yields has increasingly become a story about supply, credibility and the price investors demand to finance a rapidly expanding government debt burden.

Ray Dalio is adding another risk to that discussion: two of America’s most important foreign creditors may have less appetite to keep accumulating U.S. government bonds.

Japan remains the largest foreign holder of Treasuries, while China is still one of the most important despite years of declining reported exposure. Together, the two economies have historically provided a deep pool of demand for U.S. debt, helping Washington finance persistent fiscal and current-account deficits.

That relationship becomes more important when the 10-year Treasury yield is already around 5.3%, close to levels last seen in 2002, and investors are questioning how much additional yield will be required to absorb future issuance.

The central risk is not necessarily that China or Japan suddenly dump Treasuries. A much slower process could be enough to matter. If they stop reinvesting at the same pace, reduce allocations gradually or redirect more capital toward domestic assets, the U.S. must find other buyers.

Those buyers may demand a higher price.

Why China’s Treasury demand has changed

China’s reported Treasury holdings have declined dramatically from their peak.

Mainland Chinese holdings stood at roughly $1.3 trillion in 2013. By July 2026, the reported total had fallen to around $618 billion.

That decline should not be interpreted too mechanically. Some Chinese Treasury exposure may be held through custodians in other financial centers rather than being recorded directly under China.

Belgium is particularly important in this discussion. Treasury holdings attributed to Belgium recently stood at approximately $470.7 billion, and market analysts have long argued that part of that amount could reflect Chinese assets held through custodial accounts.

The exact level of Chinese exposure is therefore uncertain.

The trend is much clearer.

China no longer appears willing to accumulate U.S. government debt on anything resembling the scale seen during the 2000s and early 2010s.

There are both economic and geopolitical reasons for that change.

China has sought to diversify its reserve portfolio, while the increasingly adversarial relationship between Washington and Beijing creates an obvious strategic question around holding large quantities of another country’s government debt.

For a creditor, political relations matter when the debtor is also a strategic rival.

China does not need to sell aggressively to influence yields

The biggest misconception around China's Treasury holdings is that markets need to see a dramatic liquidation for the effect to matter.

They do not.

The U.S. Treasury market is constantly refinancing existing debt while financing new deficits. This means Washington needs a continuous flow of demand, not merely investors willing to keep their current bonds until maturity.

If China simply stops adding exposure while Treasury supply continues expanding, someone else must absorb the difference.

That can happen through U.S. households, banks, pension funds, asset managers, hedge funds and other foreign investors.

But these groups tend to be more price-sensitive than reserve managers.

A central bank may buy Treasuries because it needs liquid dollar reserves. A private investor is much more likely to ask whether 5.0%, 5.3% or 5.5% provides enough compensation for inflation, fiscal and duration risk.

That distinction is crucial.

Less reserve-driven buying can mean a higher market-clearing yield even without a foreign buyer strike.

Japan presents a different risk

Japan’s relationship with Treasuries is structurally different from China’s.

Tokyo is a close U.S. ally and the largest foreign holder of American government bonds, with Treasury holdings of around $1.1 trillion in July.

But Japan’s holdings fell by $12.8 billion during that month, which included intervention by Japanese authorities to support the yen.

Recent reserve data has suggested Japan likely sold part of its foreign securities portfolio to finance currency intervention.

That creates an important connection between USD/JPY and the U.S. Treasury market.

When Japan buys yen in the foreign-exchange market, it needs dollars or other foreign currency to execute the operation. One source of that liquidity can be the sale of reserve assets, including Treasuries.

If renewed yen weakness forces Japan to intervene repeatedly, Treasury holdings could become a source of funding again.

The risk is not political hostility toward U.S. debt.

It is changing domestic economics.

Higher Japanese yields make Treasuries less attractive

The Bank of Japan is also changing the relative appeal of overseas bonds.

Japanese interest rates have risen significantly as the BOJ normalizes policy. That gives domestic banks, insurers and pension funds an alternative they did not have for much of the past two decades.

When Japanese government bonds offered extremely low or negative yields, institutions had strong incentives to invest abroad.

That trade becomes less compelling as domestic yields rise.

Currency hedging costs matter as well. A Japanese investor buying Treasuries does not simply compare the headline U.S. yield with the JGB yield. The investor must also account for the cost of hedging dollar exposure back into yen.

As Japan raises rates and global currency markets remain volatile, the economics of overseas fixed-income allocations can change materially.

This means Japanese Treasury demand could weaken even without a deliberate government decision to reduce exposure.

Repatriation can occur simply because the return available at home becomes competitive again.

Why 5.3% on the 10-year Treasury matters

The 10-year yield near 5.3% is more than a psychologically important level.

It is evidence that investors are demanding significantly more compensation to hold long-duration U.S. government debt.

Several forces are contributing.

• Inflation remains elevated.
• Federal borrowing requirements are enormous.
• The Treasury market must refinance a large stock of existing debt while funding new deficits.
• Foreign official demand is less automatic than it once was.
• Private investors are increasingly becoming the marginal buyer.

All of those factors can push the term premium higher.

This is important because long-term Treasury yields influence borrowing costs far beyond the federal government. Mortgage rates, corporate debt, infrastructure financing and many other forms of credit are priced relative to government bonds.

A sustained rise in Treasury yields therefore tightens the economy even if the Fed does nothing.

The real risk is a buyer problem, not a default problem

When investors hear the phrase “U.S. debt crisis,” the first interpretation is often default.

That is not the most useful way to think about the current risk.

The United States borrows in its own currency and retains extraordinary financial capacity.

The more realistic market risk is that debt becomes increasingly expensive to finance.

If investors demand higher yields to absorb Treasury issuance, federal interest costs rise. Higher interest costs then increase deficits, forcing additional borrowing.

That can create an uncomfortable feedback loop.

More debt leads to more interest expense. More interest expense contributes to larger deficits. Larger deficits require more issuance. More issuance may require still higher yields.

This is the dynamic behind concerns that the U.S. could eventually approach the limits of its current fiscal trajectory.

The crisis, if one develops, may initially appear through price rather than an inability to borrow.

Bessent is betting that growth can bend the debt curve

Treasury Secretary Scott Bessent has argued that stronger economic growth combined with spending restraint can change the trajectory of U.S. borrowing.

That is theoretically possible.

If nominal GDP grows faster while deficits narrow as a percentage of the economy, the debt burden becomes easier to manage even if the nominal stock of debt continues rising.

The challenge is execution.

Markets need evidence that future deficits will genuinely narrow.

If growth remains strong but fiscal spending stays elevated, the government may still need enormous amounts of financing. If fiscal tightening is too aggressive, growth itself could weaken.

The bond market is therefore looking for a credible combination of stronger productivity, controlled spending and sustainable revenues.

Until investors see that adjustment, higher yields can act as the market’s own form of fiscal discipline.

AI is competing with the U.S. government for capital

The Treasury is not the only borrower asking investors for enormous amounts of money.

Technology companies are financing one of the largest investment cycles in modern history as they build data centers, semiconductor infrastructure, power generation and networking capacity for artificial intelligence.

Dalio highlighted the growing dependence of hyperscalers on debt financing.

Earlier stages of the AI boom could be funded heavily through equity and internal cash generation. As investment requirements grow, more companies are turning toward bond markets.

This creates direct competition for capital.

An investor choosing between a Treasury yielding more than 5%, a high-grade technology bond offering an additional spread, or equities expecting strong AI-driven earnings growth must decide which return best compensates for risk.

The larger all of these financing needs become simultaneously, the higher the equilibrium cost of capital may need to be.

This is one reason the rise in bond yields may be more structural than temporary.

Higher yields could eventually test the AI investment boom

The relationship also works in reverse.

AI investment is helping push demand for capital higher, but rising yields eventually make those investments more expensive.

Projects that appear attractive with cheap financing may become less compelling when debt costs rise materially.

Large technology companies with enormous free cash flow can absorb higher rates better than weaker firms, but even hyperscalers eventually face capital-allocation limits.

That could become an important economic transmission mechanism.

If higher Treasury yields raise borrowing costs enough to slow AI capital expenditure, one source of demand for capital begins to weaken.

But that would also remove an important source of economic growth and equity-market optimism.

The market is therefore caught in an unusual cycle where strong investment contributes to higher yields, while those higher yields may eventually constrain the investment itself.

Foreign selling would matter more in today’s fiscal environment

China and Japan have reduced Treasury exposure before without causing a crisis.

The difference today is the surrounding environment.

Washington is borrowing heavily.

Long-term yields are already elevated.

Inflation remains above comfortable levels.

Private corporate issuance is large.

Foreign official investors are less dominant than they were around the Global Financial Crisis.

That means a decline in demand from a major creditor may have a larger marginal effect than the same move would have had when Treasury supply was smaller and central banks were accumulating reserves rapidly.

The issue is capacity.

There will almost certainly be buyers for U.S. government bonds.

The question is how high yields must rise before enough buyers appear.

China and Japan should not be treated as the same Treasury story

It is also important not to combine China and Japan into a single narrative.

China’s reduced Treasury exposure reflects reserve diversification, slower accumulation and geopolitical considerations.

Japan’s position is more connected to monetary policy, currency intervention and increasingly attractive domestic yields.

These are very different motivations.

They can still produce the same market effect.

Both can reduce the amount of foreign official demand available to absorb new Treasury supply.

That leaves a larger role for price-sensitive private investors.

And price-sensitive investors tend to demand higher yields when fiscal uncertainty rises.

France shows this is not only an American problem

The pressure on sovereign bond markets is global.

France has become one of the clearest examples, with its bond market suffering severe losses as investors reassess fiscal deficits and political uncertainty.

Dalio argues that France has effectively reached a dangerous borrowing threshold.

The comparison with the United States should not be taken too far because the two countries operate under very different monetary systems.

France does not control the currency in which its government bonds are denominated independently of the euro area. The United States issues the world’s dominant reserve currency and has a much deeper Treasury market.

Still, the broader lesson is relevant.

Large developed economies are no longer automatically receiving cheap financing simply because their bonds were historically considered safe.

Markets are increasingly differentiating between fiscal trajectories.

What would signal that foreign Treasury demand is becoming a real problem?

The most important evidence would not be a single month of Chinese or Japanese selling.

A more serious warning would involve several developments occurring together: sustained reductions in official foreign holdings, weaker Treasury auction demand, rising term premiums, higher yields despite cooling inflation and increased dependence on leveraged or price-sensitive private buyers.

Currency behavior would matter too.

Historically, periods of global stress often produced both a stronger dollar and lower Treasury yields as capital rushed into U.S. assets.

If future risk-off episodes instead produce a weaker dollar alongside rising long-term yields, that would suggest investors are questioning the traditional safe-haven relationship.

That would be a much more consequential signal than modest monthly changes in foreign holdings.

Why China and Japan matter for the future of US Treasury yields

Ray Dalio’s warning should not be reduced to a prediction that China and Japan are about to dump U.S. government bonds.

The deeper issue is that the financing structure of the Treasury market is changing at the same time as America needs extraordinary amounts of capital.

China’s reported holdings have fallen from roughly $1.3 trillion in 2013 to $618 billion, while Japan’s position declined to around $1.1 trillion in July. Neither country needs to sell aggressively for this trend to matter.

If they simply become less willing to finance additional U.S. borrowing, more debt must be absorbed by investors who care intensely about yield, inflation and fiscal risk.

At the same time, AI companies are competing for capital, Japan is offering increasingly attractive yields at home, and the U.S. 10-year Treasury is already trading near 5.3%.

This is why the buyer question matters so much.

The United States is unlikely to suddenly run out of investors willing to own Treasuries.

But it may increasingly have to pay them more.