Treasuries Not Safe Enough as Foreign Purchase Pace Slows
Foreign investors, the bulwark of the U.S. government bond market as it more than doubled in size during the financial crisis, are adding Treasuries at the slowest pace since 2006 amid the worst rout in four years.
Holdings by non-U.S. investors rose 1.9 percent through May, down from 5.2 percent a year ago data last week show, as foreigners owned less than 50 percent of Treasuries outstanding for the first time since March 2012. Overseas central banks cut the amount of bonds held for them by the Federal Reserve during the second quarter. The Bloomberg U.S. Treasury Bond Index fell 2.4 percent, the most since 2009, after Chairman Ben S. Bernanke said he might slow asset purchases as the economy improves.
Diminished demand comes as institutions recalculate their expectations for yields. International buyers had kept pace as the market expanded to $11.4 trillion from $4.4 trillion in 2007, supporting President Barack Obama’s efforts to end the longest recession since the 1930s. The biggest sellers this year are from the Caribbean, the domicile for hundreds of hedge funds that are typically first to react to changes in interest-rate policies.
“If foreign central banks are not an incremental buyer of new Treasuries and the Fed is ‘going to taper, if,’ then the Treasury will have to find another source” of demand, Thomas Atteberry, a Los Angeles-based fund manager at First Pacific Advisors Inc., which manages $24 billion in total assets, said in a July 18 telephone interview. “And that source wants a higher return to commit their money.”
First Pacific only owns Treasuries that mature in a maximum of six months, he said.
International holdings of U.S. government debt fell $45.8 billion, or 0.8 percent, in April and May to $5.678 trillion, or 49.8 percent of bonds outstanding, based on Treasury (BUSY) Department data released last week. The two-month decline was the first since 2005.
Finance officials in developing countries that were trying to depress the value of their currencies to boost exports reversed course in order to prevent too steep a drop, Ira Jersey, an interest-rate strategist at Credit Suisse Group AG in New York, said in a July 16 telephone interview. The firm is one of the 21 primary dealers that are obligated to bid at the Treasury’s debt auctions.
“This period when the Fed appears to be transitioning to normalization of interest rates is of course a challenge to reserve managers who need to hold dollars for fundamental reasons,” Philippine central bank Governor Amando Tetangco said in an e-mail response to questions July 18. The nation increased its holdings 0.5 percent to $39.5 billion in May from $39.3 billion the previous month.
The biggest exception was China, the largest foreign owner. The nation boosted its stake this year by $95.5 billion, or 7.8 percent, to $1.316 trillion, the most on record. The world’s second biggest economy has added U.S. bonds in seven of the last eight months, buying $25.2 billion in May as the benchmark 10-year yield rose to 2.17 percent, then the highest level since April 2012.
Central bank sales probably were “far more significant in June,” and helped push two-year note yields to as high as 0.43 percent on June 26 from as low as 0.19 percent in May, Sebastien Galy, a senior foreign-exchange strategist in New York at Societe Generale SA, France’s largest bank, said in a telephone interview on July 16.
Yields for the benchmark 10-year Treasury note fell 10 basis points, or 0.10 percentage point, last week, to 2.49 percent, as the 1.75 percent note due May 2023 rose 26/32, or $8.13 per $1,000 face value, to 93 20/32. The yield dropped one basis point to 2.47 percent as of 12:12 p.m. in New York.
The 10-year yield reached 2.75 percent on July 8, the highest since August 2011, from a low this year of 1.61 percent on May 1. The selloff escalated after Bernanke, following the completion of a two-day meeting of the Federal Open Market Committee on June 19, said the Fed might scale back its $85 billion a month of bond buying this year and end it by mid-2014.
“Our Japanese customers, who have been tremendous buyers of Treasuries, stepped back because they don’t like to stop the falling knife,” Thomas Roth, a senior Treasury trader in New York at Mitsubishi UFJ Securities USA Inc., a unit of Japan’s biggest lender, said in a telephone interview July 18.
Yields have since dropped to as low as 2.46 percent on July 17, after Bernanke told the House Financial Services Committee that if economic “data are stronger than we expect, we’ll move more quickly” to reduce purchases. If the numbers “don’t meet the kinds of expectations we have about where the economy’s going, then we would delay that process or potentially increase purchases for a time,” he said.
Policy makers have said they won’t raise benchmark interest rates, which they have kept in a range of zero to 0.25 percent since 2008, until unemployment falls below 6.5 percent while the inflation rate remains under 2.5 percent.
“There’s optimism about the U.S. economy,” Michael Pond, the head of global inflation-linked research at Barclays Plc, another primary dealer, said in a July 15 telephone interview. On recent trips to Asia, foreign officials “were hesitant, but wanted to put on bearish positions” in Treasuries to reflect that, he said.
U.S. employers added 195,000 workers for the second straight month in June and wages increased as the world’s largest economy gained momentum, while the jobless rate held close to a four-year low at 7.6 percent.
The unemployment benchmark might be reached by the end of next year, based on estimated growth in gross domestic product of 3 percent to 3.5 percent in 2014, according to the FOMC’s June central tendency estimates, which are higher than the 2.9 percent estimate of private forecasters in a Bloomberg survey. GDP expanded at a 1.8 percent pace in the first quarter.
The improving outlook came as Hong Kong reduced its holdings of U.S. government securities by 6 percent to $137.8 billion, Singapore also cut 6 percent to $92.2 billion and Thailand slashed its total by 20 percent to $54.6 billion since March, Treasury data show.
Private investors joined the retreat, pulling about $8.1 billion from mutual funds that invest in bonds during the week through July 10, according to data from the Washington-based Investment Company Institute released July 17. Assets flowed out of the funds for six straight weeks, the longest stretch since December 2008, and totaled $74.8 billion. Customers added $4.55 billion to U.S. equity funds during the period, ending seven consecutive weeks of withdrawals.
“With yields as low as they were, and clearly the Fed suppressing them below what their fundamental value would be, people didn’t see value in the Treasury market,” Thomas Higgins, a global macro strategist in Boston at Standish Mellon Asset Management Company LLC, said in a telephone interview on July 18. The debt management group of Bank of New York Mellon has $167 billion of fixed-income assets.
Measures of projected bond market volatility show that investors are becoming less concerned that yields will change abruptly. The Bank of America Merrill Lynch MOVE index dipped to a seven-week low of 77.45 on July 18 from 117.89 on July 5, its highest level since December 2010.
Deutsche Bank AG Co-Chief Executive Officer Anshu Jain praised the Fed for fostering a “slow, smooth” adjustment in the bond market as it plans to curtail debt purchases. The central bank should be happy with how the bond market has reacted, Jain said July 17 in a Bloomberg Television interview.
Yields on 10-year Treasuries will rise this year to 2.63 percent, based on the median of 67 estimates in a Bloomberg survey.
The Fed pumped more than $3 trillion into the financial system through bond purchases since 2008. It held a record $1.96 trillion of Treasuries on July 17, up $300 billion, or 18 percent, from the end of 2012. Foreign purchases totaled $104.6 billion through May, a 1.9 percent increase. International investors had raised U.S. bond holdings by more than 10 percent each year since 2006.
Treasury holdings by Caribbean nations fell $30.9 billion, or 10.9 percent, in May to $253.2 billion, the biggest drop for any country or group.
“American hedge funds domiciled in Greenwich, Connecticut, that have their nameplates in the Cayman Islands were huge sellers of Treasuries in May,” Jim Bianco, president of Bianco Research LLC in Chicago, said in a July 17 telephone interview. Hedge funds, many of which are registered in the Caribbean, “move a lot of faster than everybody else,” he said.
Foreign central banks reduced custody holdings at the Fed to $2.94 trillion as of July 17, the least since Feb. 6 and the fifth consecutive weekly reduction. They owned $2.97 trillion on June 12.
“There is a shift occurring with a kind of leveling out of Treasury purchases,” Michael Brandes, global head of fixed-income strategy for Citigroup Inc.’s Citi Private Bank, with $270 billion in assets under management, said in a July 18 interview. “We are coming to an inflection point in the U.S. rate cycle with the trend for higher yields.”
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