Morning Note: Market News and US Current Account Deficit
Market News
Markets: Another lacklustre day on Wall Street saw the S&P 500 trade broadly unchanged at 6005.88 +5.52 (+0.09%). Asian stocks mostly gained while US and European futures were mixed. Chinese shares erased gains. The yen weakened after Kazuo Ueda said the BOJ is still some distance from its inflation goal. Treasuries dipped and Brent inched higher.
Trade talks between the US and China continue into a second day as the two sides look to ease tensions over shipments of technology and rare earth elements. “We are doing well with China,” Donald Trump told reporters, adding “China’s not easy.” Scott Bessent said they had a “good meeting,” and Howard Lutnick called the discussions “fruitful.”
UK: Chancellor Rachel Reeves will announce a £14.2 billion investment to help construct the Sizewell C nuclear plant in a wide-ranging spending review tomorrow. It will include plans to offer cheaper financing for housebuilders, the FT reported.
Corporate: Diageo is said to consider a sale of all or part of its IPL Bengaluru franchise and may seek a valuation of as much as $2 billion. Abigail Johnson’s family VC fund is said to be planning to unload Chinese tech holdings. Thames Water creditors submitted a rescue plan that involves £5 billion of fresh funds and losses for debt holders. Mark Zuckerberg is personally recruiting experts and scientists for a new “superintelligence” AI team at Meta.
Iran Nuclear Talks: Trump said Iran is pushing for uranium enrichment, expressing worry that it is seeking too much in a potential nuclear deal. The two sides will hold a new round of talks in Oman on Sunday, Tehran said.
LA Riots: The Trump administration is sending about 700 Marines in response to immigration-raid protests in LA. California is asking a federal court to halt the “illegal” deployment of the National Guard and Marines. Trump backed comments suggesting Governor Gavin Newsom should be arrested over his handling of unrest. Waymo suspended service in downtown LA after its vehicles were set on fire.
US Current Account Deficit: Who's Financing It?
https://www.cfr.org/blog/dollars-global-role-and-financing-us-external-deficit
This article references a recent blog article by Brad Setser (link above), who is one of the leading experts on capital account flows. We highlight this important article as it contains some critical insights into the flows into US financial markets, what drives them and what this might mean for the future.
The traditional view of reserve accumulation is that the U.S. current account deficit was financed in large part by foreign central banks accumulating dollar reserves, particularly from Asia. These flows were yield-insensitive: central banks bought U.S. Treasuries and Agencies not for returns, but for liquidity and safety. This created persistent demand for U.S. bonds, helping to lower yields. Until ~2014, East Asian reserve growth tracked their current account surpluses closely as reserves rose in lockstep with trade surpluses.
Since 2014, central bank reserve accumulation has slowed sharply, even as U.S. deficits remain large. The gap is now being filled by private investors (pension funds, insurers, sovereign wealth funds) seeking higher returns, not safety. This includes Asian insurers (e.g., Taiwan’s life insurers) buying U.S. bonds for yield. European investors allocating to U.S. tech and fixed income markets. Institutional buyers (like Japan’s GPIF) shifting from domestic to global assets. Private flows are return-sensitive, volatile, and may reverse, unlike passive reserve accumulation.
The traditional “safe haven” bid from reserve managers is less powerful today. If bond yields rise globally or U.S. returns falter, foreign private demand could fall. Less structural demand could lead to higher U.S. borrowing costs and a greater sensitivity of U.S. yields to global risk sentiment. The argument that reserve currency status “anchors” U.S. bond yields is weaker now.
For U.S. equities, the demand for U.S. stocks (particularly tech) reflects belief in U.S. exceptionalism, i.e., long-term superior growth and returns. This makes U.S. equities vulnerable if the growth narrative weakens, valuations become unsustainable or global investors reallocate to cheaper regions. If flows reverse, equity markets could see sharper drawdowns than in a world dominated by sticky reserve flows.
The dollar’s dominance as a reserve currency matters less than the belief in U.S. outperformance. U.S. financial markets are now more dependent on private capital that can reverse course quickly. The U.S. can no longer count on passive inflows from central banks to suppress borrowing costs. Any disillusionment with U.S. assets could drive up bond yields and pressure equities simultaneously.
