I think that Federal Reserve flow of funds table F107 (Rest of the World) and table F209 (Treasury securities) should cast some light on this matter. Table F209 shows that net issues of Treasury securities fell from $307.3 billion in 2005 to $183.7 billion in 2006. This is consistent with increased federal tax revenues that accompanied economic recovery.

At the same time, table F107 shows that Net acquisition of financial assets by the “Rest of the World” rose from $1040.9 billion in 2005 to $1568.9 billion in 2006. This is consistent with the increase in the trade deficit over the period.

Net foreign investment in Treasury securities from table F107, dropped from $287.1 billion in 2005 to $141.1 billion in 2006. In fact, net foreign investment in Treasury securities has been falling since 2004.

However, net foreign purchases of asset-backed securities, corporate bonds, and equities increased.

It would seem that falling net foreign purchases of Treasury securities is, in part, a reflection on decreased supply, due to a slowing in the rate of increase of the fiscal deficit, and, in part, a shift in preferences for different kinds of financial assets.

A key number to watch is net foreign purchases of credit securities in general, which increased from $815.6 billion in 2005 to $825.7 billion in 2006 which suggests that the trade deficit continues to support prices of debt securities in general.