Foreign Demand for U.S. Treasuries: A Catalyst for Sectoral Rotation and Biotech Reallocation

The surge in foreign demand for U.S. Treasuries in 2025 has emerged as a pivotal force reshaping capital markets. According to the Treasury International Capital (TIC) data for May 2025, foreign residents added $318.5 billion to their holdings of long-term U.S. securities, with private investors accounting for the lion's share. Japan, the UK, and China remain key players, though the UK's $809.4 billion stake now eclipses China's $756.3 billion—the first time since 2000. This shift underscores a recalibration of global capital flows, driven by the U.S. dollar's enduring allure as a reserve currency and the search for yield in an era of fiscal uncertainty.

The Yield Curve and Sectoral Rotation

The bear steepening of the U.S. Treasury yield curve—where long-term yields outpace short-term ones—has become a defining feature of 2025. The spread between 2-year and 10-year Treasuries widened to 50 basis points, while the 5s30s spread hit 85 basis points, the widest in a decade. This steepening is not merely technical; it reflects strategic capital reallocation by foreign investors. For instance, Japanese and European buyers are increasingly hedging their FX exposure using short-term Treasuries while locking in higher long-term yields.

This dynamic has profound implications for sectoral rotation. As foreign capital floods into Treasuries, investors are derisking portfolios, favoring income-generating assets over high-growth, high-volatility sectors like biotech. The S&P 500's Information Technology and Communication Services sectors have outperformed, while Health Care and Energy lagged in Q2 2025. The biotech sector, in particular, faces downward pressure as rising Treasury yields elevate discount rates, compressing valuations for long-duration assets.

Biotech Exposure: A Tale of Two Forces

The biotech sector's performance in 2025 is a tug-of-war between macroeconomic headwinds and innovation-driven tailwinds. On one hand, the surge in Treasury demand has amplified risk-off sentiment, reducing appetite for speculative biotech plays. On the other, breakthroughs in mRNA cancer vaccines and CRISPR therapies are attracting niche capital, particularly from AI-driven drug discovery firms.

Consider the case of Vertex Pharmaceuticals, which has prioritized high-potential genetic disease targets while cutting R&D costs. Its stock has outperformed the broader biotech index, reflecting investor confidence in operational discipline. However, smaller firms with unproven pipelines face a liquidity crunch, as venture capital flows have dipped to $5–7 billion quarterly.

Strategic Asset Allocation: Navigating the New Normal

For investors, the key lies in balancing the safety of U.S. Treasuries with the growth potential of biotech. Here's how to position portfolios for 2025:

1. Leverage the Steepening Curve: Allocate to long-duration Treasuries, particularly 30-year bonds, which offer a 6.2% yield. This provides a hedge against inflation while generating income in a rising rate environment.
2. Target Defensive Biotech: Focus on large-cap biotech firms with diversified pipelines and strong balance sheets. Vertex, Amgen, and Biogen exemplify this profile.
3. Hedge with AI-Driven Innovators: Invest in biotech firms leveraging AI for drug discovery, such as Recursion Pharmaceuticals and Insilico Medicine. These companies are less sensitive to interest rate volatility and benefit from secular growth trends.
4. Diversify Geographically: Allocate to biotech ETFs with exposure to Asia and Europe, where aging populations and healthcare reforms are driving demand for innovative therapies.

Policy Tailwinds and Risks

Regulatory shifts could amplify these dynamics. The potential exclusion of U.S. Treasuries from the Fed's supplementary leverage ratio (SLR) could unlock $1 trillion in new demand from domestic banks, further steepening the yield curve. Conversely, a slowdown in global economic growth or a U.S. dollar correction could curb foreign appetite for Treasuries, triggering a rotation back into risk assets.

Conclusion: The New Equilibrium

The 2025 surge in foreign Treasury demand is not a temporary blip but a structural shift in global capital flows. While this has dampened biotech's growth story, it has also created opportunities for selective investors. By aligning portfolios with the steepening yield curve and focusing on biotech's innovation moats, investors can navigate the evolving macroeconomic landscape with resilience and foresight.

Actionable Insight: Monitor the Bank of Japan's rate hike schedule and the Fed's SLR reform timeline. These events could catalyze further capital reallocation, offering timely entry points for strategic asset allocation.