The next 12 months are expected to be among the most severe stress tests for the modern U.S. dollar-based financial system. This is due to the need for substantial U.S. Treasury issuances (around $3 trillion), with non-resident purchases likely to decline to near zero - or even result in net sales - unless the Federal Reserve intervenes. This occurs amidst the depletion of the integral stability buffer: a zero liquidity surplus coupled with declining net national savings.
In other words, the need to accumulate debt peaked in 2020 - 2021, but the available resources to meet this need are now lower than ever relative to the magnitude of the debt requirements.
The Role of Households in Treasury Market Stability
Peaks in the accumulation of cash flows in bonds have always been accompanied by sell-offs in the equity market.
Households play a crucial role in stabilising the government bond market, especially when non-residents and the Federal Reserve are not active buyers. As a result, it seems almost inevitable that liquidity will continue to be concentrated in government bonds, even if this trend may be to the detriment of the equity market.
Historical Context of Bond and Equity Allocations
By historical standards, the concentration of bonds in total financial assets is at an all-time low (4.7%), comparable to the early 2000s and 1983.
The ratio of bonds to disposable income stands at 27% - similar to 2019 levels - compared to a peak of around 40% in 2009.
In contrast, equities, including investment funds, have reached record concentration levels. In the first quarter of 2025 (Q1), the ratio of equities to disposable income was 233% (with recent market lows bringing this closer to 253%). This compares to a peak of 255% in Q4 2021, significantly higher than the dot-com bubble levels of 168% in Q1 2000 and 151% in Q3 2007.
Cash, including cash, deposits, and money market funds, now accounts for 91% of disposable income, aligning with historical highs - except for the 2020 - 2021 period when excessive monetary stimulus was injected into the economy.
Potential for Liquidity Reallocation
If certain conditions are met, there is significant potential for liquidity to be reallocated in favor of the bond market. In other words, the Treasury market could be stabilized, but at the cost of a sharp collapse in the equity market.
Conclusion
In conclusion, the U.S. financial system is heading towards an inevitable large-scale liquidity reallocation in the coming months, driven by the pressing need to support the Treasury market. While households have historically helped stabilize the Treasury bond market, the current environment - characterized by record levels of equity investments and minimal bond holdings - suggests that substantial market shifts are unavoidable. A reallocation of liquidity toward bonds could temporarily stabilize the Treasury market, but it would likely come at the expense of a significant downturn in the equity market.