Norwegian Sovereign Wealth Fund May Cut $80 Billion in U.S. Treasury Holdings, High-Rated Mortgage-Backed Securities Likely to Become New Favorites

The Norwegian sovereign wealth fund, valued at $2.3 trillion, has suggested reducing its holdings in government bonds and reallocating funds towards higher-yielding fixed-income assets. The Norwegian Central Bank Investment Management (NBIM) proposed cutting the proportion of government debt in the funds bond benchmark from 70% to 50%. It is estimated that this adjustment could lead to a reduction of about $106 billion in global sovereign bond holdings, with nearly $80 billion of U.S. Treasury holdings being cut. The fund plans to redirect most of these funds towards assets such as agency mortgage-backed securities. These bonds are backed by Fannie Mae, Freddie Mac, or Ginnie Mae, thus their credit quality is similar to that of U.S. Treasuries but generally offer higher yields to compensate investors for the risk of homeowners prepaying their mortgages. For investors, this proposal again indicates that, as government borrowing continues to rise and yields remain elevated, large institutional investors are demanding higher returns from their bond portfolios. A reduction of $80 billion in U.S. Treasury holdings is not significant relative to the vast U.S. Treasury market; however, if other reserve management institutions take similar actions, it could weaken market demand for U.S. Treasuries and further push yields higher. This shift also implies that high-rated mortgage securities may become a more attractive alternative to government bonds. These adjustments will keep the overall dollar exposure of the fund largely unchanged. The weight of U.S. Treasuries will drop by 12.2 percentage points, while the allocation to other U.S. fixed-income securities will increase by 11.4 percentage points. The proportion of holdings in U.K. government bonds will remain unchanged, while the weight of Japanese sovereign debt will rise. NBIM also suggested setting weights for government bonds based on the size of each countrys outstanding government debt, rather than the size of each countrys economy. The fund stated that broader reforms will diversify its sources of fixed-income returns while maintaining ample liquidity during market stress periods. This proposal has not yet been finalized. An expert committee is expected to submit more comprehensive recommendations to the Norwegian Ministry of Finance before January next year, while the Norwegian government plans to present related proposals to Parliament in the spring of 2027. Since the beginning of this year, yields on long-term U.S. Treasuries have continued to rise, driven by persistent inflation, as well as increasing investor concerns over whether the Federal Reserve will raise interest rates to curb inflation. Additionally, the widening U.S. federal budget deficit, along with massive bond issuances by tech companies to fund artificial intelligence (AI) expenditures, have also been crucial factors contributing to the upward pressure on the long end of the yield curve, competing with sovereign bonds. After experiencing severe volatility last week, U.S. Treasury investors are preparing for another trading week that could trigger even larger price swings. In the week following Labor Day, two key events will unfold: on Wednesday, the U.S. Treasury will announce the details of an expanded bond buyback program set to launch the following day, possibly doubling or even exceeding its previous cap; on Friday, August inflation data will be released, which is considered a core reference point by Federal Reserve Chair Kevin Warsh and his colleagues in deciding whether to raise interest rates this month. Investors will need to navigate these two opposing forces simultaneously this week. Short-term Treasuries may be pressured by rising rate hike expectations, while long-term Treasuries could find support from the stabilizing effects of the buyback programhow the shape of the yield curve evolves will depend on which force prevails.