Ray Dalio Warns of Long Road Ahead in US Bond Bear Market Amid Supply Glut

What happened

Ray Dalio, founder of Bridgewater Associates, warned that the US bond bear market is far from over, describing the current scenario as the middle of a cycle he had previously mapped out. According to Dalio, the supply of debt and equity coming to market is significantly larger than investors can absorb without higher yields and lower prices. He notes that developments since the publication of his book in June 2025 have closely followed his template, with interest rates rising sharply and central banks tightening monetary policy, but without these moves having fully impacted stocks, credit spreads, and economic activity.

Dalio highlighted that marketable Treasury debt totals about $32 trillion, up 8% in a year, with approximately $2.1 trillion of net new issuance expected in 2026. The Treasury has leaned heavily towards short-term bills, which now account for about half of issuance compared to a historical target of around 20%. While this eases pressure on long-dated yields, it increases rollover risk and makes interest costs more volatile. Regarding demand, Dalio pointed out that foreign investors hold about 32% of Treasuries and the Fed about 14%, with support shifting towards domestic buyers. He emphasized that China and Japan, major holders, have incentives to reduce their positions, which could disruptively unwind currency-hedged carry trades. Middle Eastern oil exporters are also reportedly buying less US debt. Debt service costs are another pressure point, with the average rate on existing debt at about 3.5%, while market rates range from 4% to 5.5%, indicating that interest costs will continue to climb.

Why it matters

Dalio's analysis is crucial because it suggests that upward pressure on long-dated Treasury yields will be sustained, driven by heavy debt issuance and weakening demand from foreign buyers. This implies a steeper yield curve and keeps term premium in focus. The potential repatriation of Japanese capital, unwinding currency-hedged Treasury holdings, could support the yen and Japanese government bonds while adding to selling pressure on US debt. For credit, the focus on accelerating hyperscaler issuance and declining free cash flow suggests that AI-linked corporate bonds may need to offer wider spreads to clear the market. Equities, according to Dalio, are a lagging risk; their vulnerability will emerge once higher yields start to bite, with a surge in AI-related equity supply adding to the strain. Reduced demand for US debt from Middle Eastern oil exporters also ties the outlook partly to energy markets, as oil revenues shape their capacity to recycle surpluses into Treasuries.

Market impact

• Interest rates and bonds: Long-dated Treasury yields tend to rise, reflecting unfavorable supply and demand dynamics. The yield curve may steepen, with longer maturities rising more than shorter ones. Japanese repatriation could add selling pressure on Treasuries.
• Dollar and FX: Japanese capital repatriation could strengthen the yen. Selling pressure on Treasuries could, in theory, weaken the dollar, although the context of higher US rates might provide support at other times.
• Equities: Stocks are seen as a lagging risk. When higher yields begin to impact financing costs and company valuations, especially for AI-linked companies with high equity issuance, a correction may occur. Interest-sensitive sectors tend to be more affected.
• Commodities: Reduced demand for US debt from Middle Eastern oil exporters may have implications for energy markets, given that their oil revenues influence their capacity to invest in Treasuries.
• Brazil: A global scenario of higher US yields and lower risk appetite tends to be negative for emerging markets. The real may depreciate, and local interest rates may rise, reflecting global risk aversion and the need for a premium to attract capital.

What to watch

It will be crucial to monitor US Treasury debt issuance data and the composition between bills and bonds. Tracking foreign investment flows into Treasuries, especially from Japan and China, will be key to assessing demand. Additionally, reports on corporate free cash flow and corporate debt issuance, particularly in the tech and AI sectors, will provide insights into the health of the credit market. Finally, the evolution of US government debt service costs and the reaction of equity markets to a higher-rate environment will be key indicators.

Scenarios

Base Scenario: Treasury yields continue under upward pressure, with the yield curve steepening. Equity and credit markets begin to feel the effects of higher rates, leading to a gradual correction. The dollar may experience volatility, with the yen strengthening in the event of repatriation. Risk Scenario: More aggressive Japanese capital repatriation than expected or a sharper reduction in Treasury purchases by other major holders could accelerate yield increases and trigger a more significant correction in global equity and credit markets, with more severe impacts on emerging markets.

Original source: ForexLive (InvestingLive). For information only, not investment advice.