DB: Хьюстон доллар, у вас проблемка!

It is simple. The US cannot close its very large current account deficit unless it closes its fiscal deficit too. But over the last few days we are learning something very important: the US appears unwilling to do that. The emerging reconciliation bill from the US Congress points to ever-wide fiscal deficits above 6%. The US - China trade accord effectively signals a very low pain threshold on taxing (tariffing) the US consumer. In all, even if we account for the (now diminished) revenues from tariffs the US budget deficit will keep growing. The current account deficit will likely keep widening in this scenario too.

The significance of this conclusion cannot be over-estimated. The market is reducing its willingness to fund US twin deficits. This is arguably entirely reasonable given the expressed US desire to reduce them. But actions speak louder than words: the newsflow over the last few days aligns with the opposite outcome. We worry this is brewing a major problem for the dollar and potentially the US bond market too.

The rationale is as follows. The US has a record negative net international investment position, the most rapidly deteriorating and largest in the world. This is reflective of three things: very large foreign ownership of US assets, extreme valuation of dollar assets and the very expensive dollar itself. Running a wider fiscal deficit requires foreigners to buy an ever-expanding amount of US Treasuries and an ongoing rise of America's foreign liabilities. This we believe is no longer sustainable.

To see this, consider our long-held argument that the best metric of fiscal space is a country's net international investment position (NIIP). The greater the amount of money a country owes to the rest of the world, the more difficult it is to borrow more money. This can be seen in the very tight relationship between sovereign yields and the NIIP (chart 4), far tighter than the corresponding relationship to fiscal deficits. The current path of America's deteriorating net foreign asset position implies UST yields well above 5% over the next few years. We believe foreigners are becoming increasingly aware of this dynamic as the dollar has lost some of its "special" status.

The market conclusion is clear. For foreigners to continue financing US debt one thing needs to happen: the non-dollar price of US Treasuries needs to decline, either via currency depreciation or a drop in the price of the bonds. The problem for the latter is that it makes US debt dynamics even worse so is not sustainable. We are ultimately left with the only solution to this problem being dollar weakness. That will effectively lead to a capital writedown of foreign holdings of US assets and an improvement in America's net external asset position, making it easier to finance new issuance again.

We would argue this dynamic is already playing out. Our high-frequency foreign inflow data is continuing to show very tepid inflows in to the US. There is persistent reporting of investors and countries reconsidering their dollar asset exposure, most recently in Taiwan . The discussion of "passive" currency accords implies less Treasury buying from foreign central banks, while a more globally expansive fiscal stance will reduce foreign willingness to buy USTs even more.

Perhaps the most compelling evidence of this dynamic accelerating would be an increasing decoupling of US yields from the dollar, most visibly in USD/JPY. As one of the world's biggest buyers of US fixed income,if Japan stops buying US debt you would expect to see the yen stronger and US yields higher at the same time. The bond - dollar correlation needs to be watched closely. It will be the clearest signal of an ongoing deterioration in US bond dynamics.

To sum it all up, as Secretary Bessent alluded to himself, the US cannot be asking of the rest of the world to reduce its imbalance with America if the US is not willing to reduce its own. The risk is the rest of the world forces the correction upon the US in a disorderly way.