Treasuries Lose Cachet on Lowest Foreign Demand Since ’01
The $11.6 trillion U.S. government bond market is losing some of its luster.
America’s borrowing costs are on the cusp of exceeding the rest of the world for the first time since 2010 after a political stalemate over public funding triggered a 16-day government shutdown and jeopardized the nation’s ability to pay its debt. Yields on Treasuries, which averaged less than 1 percent as recently as May, are now within 0.2 percentage point of the 1.57 percent for sovereign debt outside the U.S., according to Bank of America Merrill Lynch indexes.
While lawmakers reached an agreement last week to avert the country’s first default in its 237-year history, overseas investors who own almost half the Treasuries outstanding have reduced holdings for four straight months, the longest stretch since 2001. Their growing reluctance to finance the world’s biggest debtor nation may lift borrowing costs further and harm an economy that has yet to fully recover from the deepest recession since the 1930s. Each percentage point increase in Treasuries would boost annual U.S. funding costs by $20 billion, based on the amount of debt issued in the year ended Sept. 30.
“Default or no default, the damage is already done,” Steve Major, the London-based global head of rates strategy at HSBC Holdings Plc, Europe’s largest bank, said in a telephone interview. “Politicians are kicking the can down the road when the world needs a longer-term solution. This sort of political brinkmanship undermines confidence.”
Major, whose firm is also one of the 21 primary dealers of U.S. government securities that are obligated to bid at Treasury auctions, says that while the Federal Reserve will keep suppressing borrowing costs to buffer the economy, lingering doubts wrought by the political discord will likely cause bondholders to demand more to own the longest-dated Treasuries relative to shorter-term debt over the next year.
HSBC forecast the extra yield that investors demand to hold 30-year Treasuries instead of 10-year (USGG10YR) securities will rise to 1.2 percentage points from 1.06 percentage points last week and 0.87 point on Sept. 3, the lowest in three years.
U.S. borrowing costs have climbed faster than the rest of the world since May, with the gap narrowing by 0.24 percentage point on speculation the economy was growing enough to allow the Fed to start curtailing its unprecedented stimulus.
Yields on Treasuries now average 1.38 percent, 0.19 percentage point less than non-U.S. government debt, according to index data compiled by Bank of America. In the past five years, investors have demanded 0.36 percentage point more to own government notes outside the U.S. instead of Treasuries.
Overseas investors have sold a net $132 billion of Treasuries in the four months ended July, the longest streak in 12 years, and are poised to add to their holdings at the slowest pace since at least 2001, the most recent data show.
Their proportion of Treasuries dropped below 50 percent in April before falling to a six-year low of 48.7 percent in July, from a peak of 55.7 percent in April 2008.
While Treasuries rebounded after the accord, the debt-ceiling debate has dissuaded foreign investors from putting money in U.S. debt, according to Laurence D. Fink, chief executive officer at BlackRock Inc. (BLK), which oversees $4.1 trillion in assets as the world’s biggest money manager.
“Many of our foreign investors have had conversations with me and many at BlackRock about how should they think about investing in U.S. debt over the next two years,” Fink said in an interview on Bloomberg Television last week.
Investors are already exacting a price in the bond market, according to Michael Diekmann, the chief executive officer of Allianz SE (ALV), Europe’s biggest insurer and owner of Pacific Investment Management Co., the largest bond fund manager.
The U.S. Treasury is probably paying 0.6 percentage point more to borrow money as a result, Diekmann said in an Oct. 15 interview at Bloomberg’s headquarters in New York.
The $35 billion auction in three-month bills on that day priced at a discount rate of 0.13 percent, the highest since February 2011. The rate was 0.01 percent at the Sept. 30 sale.
Treasuries climbed last week, with 10-year yields falling 11 basis points, or 0.11 percentage point, to 2.58 percent, according to Bloomberg Bond Trader prices. The price of the benchmark 2.5 percent note due August 2023 rose 30/32, or $9.38 per $1,000 face amount, to 99 10/32.
Yields on benchmark 10-year notes rose for the first time in three days, increasing three basis points to 2.61 percent as of 1:34 p.m. in New York.
The rate on Treasury bills maturing Oct. 24 plunged to 0.015 percent from 0.26 percent last week. The rate reached a high of 0.675 percent on Oct. 16 as concern lawmakers would fail to resolve the fiscal impasse peaked.
With the largest and most-widely held government debt market and the dollar’s status as the world’s reserve currency, the political standoff in the U.S. is unlikely is cause an exodus from Treasuries, according to Kit Juckes, the global strategist at Societe Generale SA in London.
Foreign investors alone hold $5.59 trillion in Treasuries, more than three times the size of China’s government bond market. They accounted for just 8.4 percent of Japan’s $9.88 trillion of sovereign bonds, the only market that approaches the U.S. in size.
The dollar has also been the most-popular reserve currency of foreign governments since the end of World War II, and now makes up 62 percent of central bank holdings globally. China and Japan, which together have $4.87 trillion in foreign-currency reserves, keep 50 percent of their assets in Treasuries.
“The hard truth for China is that there’s no alternative for U.S. Treasuries,” Li Jie, head of the foreign-exchange reserve research office at the Central University of Finance and Economics in Beijing, said last week before the debt limit was lifted. “Whatever happens, undertaking a massive selloff of U.S. bonds is not an option.”
Five years of record-low benchmark borrowing costs in the U.S. also means the government paid less interest as a percentage of its gross domestic product in 2012 than at any time since at least 1987, even as the amount of debt more than doubled since 2008, data compiled by Bloomberg show.
In the decade through 2007, average yields on Treasuries were 1.55 percentage points higher than sovereign debt outside the U.S., index data compiled by Bank of America show.
“The country has no issue with its ability to repay its debt,” Societe Generale’s Juckes said in a telephone interview. “This is a problem of U.S. politics rather than a problem of U.S. creditworthiness. We may not get a solution that is clean and neat, but there’s still perception out there that Treasuries are risk-free.”
President Barack Obama signed legislation crafted by Senate leaders ending the shutdown and extending the U.S.’s borrowing authority on Oct. 17, the day Treasury Secretary Jacob J. Lew said the government would exhaust that authority. The debt extension is now set to expire on Feb. 7.
Lawmakers, who engaged in their fourth round of fiscal brinkmanship in less than three years, didn’t resolve any of their long-term disagreements on fiscal policy and will have to return to the same issues over the next four months.
The political wrangling undermined the perception of U.S. debt as risk-free and will probably push countries to seek alternative reserve currencies, Elvira Nabiullina, Russia’s central bank chief, said in e-mailed comments to Bloomberg News on Oct. 16.
Russia’s holdings of Treasuries have fallen by $30 billion to $132 billion this year. The 19 percent drop is the biggest among foreign holders, U.S. data show. Bank Rossii isn’t yet reviewing its Treasury investments, Ksenia Yudaeva, first deputy chairman, overseeing monetary policy, said last week.
China, the largest foreign creditor to the U.S. with $1.28 trillion in Treasuries, also expressed “concern about Washington’s debt-ceiling problem” when Premier Li Keqiang met with U.S. Secretary of State John Kerry in Brunei on Oct. 8, according to Xinhua, the official Chinese news agency.
Standard & Poor’s estimated the shutdown probably shaved at least 0.6 percent off fourth-quarter growth, and took $24 billion out of the economy.
“What’s going to happen is we are going to have a lasting penalty,” Adam Posen, president of the Peterson Institute for International Economics and a former policy maker at the Bank of England, said in a Bloomberg Television interview on Oct. 17. “The outcome is better than a default. But this is hardly what you would expect the mature democracy to do.”
Even as the dollar remains the reserve currency of choice among central banks, its share has fallen since peaking at 72.7 percent in 2001, decreasing in six of the past seven years, according to the International Monetary Fund.
Foreign purchases of Treasuries, which helped underpin the historically low rates the U.S. has enjoyed, have slowed since the stakes reached a record $5.574 trillion last year.
Official holders of U.S. government debt such as central banks and finance ministries, which own $4 trillion of Treasuries, have pared their investments by $95 billion in the four months ended July, while non-official holders including mutual funds and private investors cut their stakes by about $39 billion, the data show.
“We have switched some physical Treasury exposure earlier this month into other core markets,” John Stopford, the head of fixed income at Investec Asset Management in London, which oversees $107 billion in assets, said in a telephone interview. Although the firm didn’t forecast a default “it’s a risk we have to consider. We can’t just sit there doing nothing.”
The full faith and credit of the U.S. government has been a cornerstone of fiscal policy ever since Alexander Hamilton, the nation’s first Treasury secretary, reached a compromise with Secretary of State Thomas Jefferson and House Speaker James Madison in 1790 that enabled the federal government to assume the unpaid debts that the colonial states incurred during the Revolutionary War.
While the U.S. has never repudiated its debt, the political disputes that called into question the nation’s commitment to its obligations twice in the past two years is diminishing the government’s credibility, according to Jason Evans, co-founder of hedge fund NineAlpha Capital LP in New York and the former head of U.S. government bond trading at Deutsche Bank AG.
In 2011, when U.S. lawmakers pushed the government toward the precipice of a potential default in their first debt-ceiling stalemate, Treasuries held at the Fed for foreign central banks fell in four of the five months following its resolution. China chopped its holdings by $163 billion, or 12.4 percent, to $1.15 trillion over the same span.
“Every time we play this game it’s just a small chip away, it slightly erodes the benchmark status that Treasuries enjoy,” Evans said.
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