Treasuries’ Lure Abroad Grows in $3 Trillion Fed AccountDaniel Kruger and Wes Goodman
International investors bought more Treasuries last quarter than any other start to a year since 2009, with holdings approaching $3 trillion, as a new crisis in Europe weighs on the euro and Japan debases the yen.
The Federal Reserve’s holdings of U.S. government debt on behalf of foreign central banks rose $63.5 billion, or 2.4 percent, to $2.95 trillion as of March 27, according to the central bank. China, the largest foreign lender to the U.S., has been buying Treasuries at the fastest pace since 2011.
Rather than slowing purchases as U.S. lawmakers struggled to avoid $600 billion in automatic spending cuts and tax increases, international investors are again seeking Treasuries, underscoring their role as a store of value. The demand is helping Fed Chairman Ben S. Bernanke keep yields low, increasing investor appetite for dollars even after the central bank poured more than $2.5 trillion into the financial system since 2008.
“The U.S. is standing out as a place of relative growth, strength and stability,” Wan-Chong Kung, a bond fund manager in Minneapolis at Nuveen Asset Management, which manages more than $100 billion, said in a March 28 telephone interview. “The big, bad outcomes have been avoided.”
Overseas demand isn’t just coming from central banks. Total foreign holdings rose 0.8 percent in January to a record $5.62 trillion after rising a combined 0.9 percent in November and December, according to the latest Treasury Department data.
Foreign demand is a welcome development for President Barack Obama and the Treasury Department as they seek to finance budget deficits of about $1 trillion with bond sales just as the Fed signals it may slow the pace of its purchases as the economy improves. The central bank, which holds about $1.78 trillion of the securities, is adding $85 billion a month in Treasuries and mortgage bonds.
Gross domestic product will likely be growing at a 2.6 percent annual rate by the end of the year, compared with an average of 1.97 percent for Group of 10 nations, according to separate surveys of economists by Bloomberg.
“People are starting to view the U.S. as the growth engine of the world,” George Goncalves, the head of interest-rate strategy at Nomura Holdings Inc., one of the 21 primary dealers that trade directly with the Fed, said in a March 26 telephone interview. “We’re finally getting our act together, and you can’t write off the U.S. These foreign central banks are not going to move away. They feel comfort in the American story.”
Treasuries have rallied in recent weeks as the bailout of Cyprus prompted investors to seek the safest assets. Ten-year yields fell eight basis points last week, or 0.08 percentage point, to 1.85 percent, according to Bloomberg Bond Trader data. That’s down from this year’s high of 2.08 percent on March 8.
The price of the benchmark 2 percent note due in February 2023 rose 22/32, or $6.88 per $1,000 face amount, to 101 11/32. The market was shut on March 29 for Good Friday.
The yield was 1.84 percent today as of 11:05 a.m. in New York.
Foreign investors are pouring in as Treasuries registered a loss of 0.3 percent in the first quarter, after a 0.1 percent loss in the last three months of 2012, according to the Bank of America Merrill Lynch U.S. Treasury Master Index.
An added benefit is that Treasuries due in 10 years or more are relatively cheap, yielding about 0.54 percentage point more than non-U.S. sovereign debt, the most since 2011, Bank of America Merrill Lynch indexes show. As recently as September, Treasuries yielded less than the rest of the world on average.
Those yields will look extra appealing as the $85 billion in mandated budget known as sequestration curb growth, according to Allen Lei, a Taipei-based Treasuries trader at Hontai Life Insurance Co., which has $6 billion in fixed-income assets. The Conference Board’s consumer confidence index fell to 59.7 for March from a three-month high of 68 in February. Economists surveyed by Bloomberg projected the measure would fall to 67.5.
“We will see the economy pull back soon,” Lei said in a March 26 telephone interview. “The effects of the budget cuts will happen in the next few months.”
China is returning as a buyer after reducing holdings for more than a year. The world’s second-largest economy added $110.9 billion of Treasuries from October through January to bring its holdings to $1.26 trillion. That was the most bought by China over a four month period since July 2011. It sold $161 billion from August 2011 through September 2012.
China’s purchases may be due to concern that the value of the dollar’s two biggest competitors -- the euro and the yen -- is being diminished as reserve currencies, said Michael Cheah, who manages $2 billion in bonds at SunAmerica Asset Management in Jersey City, New Jersey.
Cyprus has become the fifth member of the euro zone to ask for a bailout, while the yen has tumbled about 18 percent since mid-September as Prime Minister Shinzo Abe encourages the Bank of Japan to print as much money as it takes to end deflation. The euro has depreciated about 21 percent since the start of 2009, Bloomberg Correlation-Weighted Indexes show.
“It make doesn’t sense for China to bring the allocation of dollar assets lower,” said Cheah, who worked at the Singapore Monetary Authority in the 1980s and 1990s. He teaches finance at New York University and at Chinese universities.
The U.S. Dollar Index, which Intercontinental Exchange Inc. uses to track the greenback against the currencies of six U.S. trading partners, has rallied 4 percent this year to 82.976, about the highest since August. The index has risen about 17 percent from its lows in 2008.
Currency valuations drive bond demand from China, which controls the appreciation of the yuan, and Japan, according to Ali Jalai, a trader of Treasuries in Singapore at Scotiabank, a unit of Canada’s Bank of Nova Scotia, a primary dealer. Asian central banks and governments are among Scotiabank’s customers.
“China buys Treasuries to protect its exchange rate,” Jalai said in a telephone interview March 28. “The weakening of the yen also increases demand for Treasuries from institutions in Japan.”
The lack of inflation in the U.S., which is reinforced by the dollar’s strength, enhances the appeal of Treasuries and will prompt the Fed to keep buying, according to Hideo Shimomura, the chief fund investor at Mitsubishi UFJ Asset Management Co., a unit of Japan’s largest publicly-traded bank.
“There’s disinflationary pressure in the U.S.,” Shimomura, who helps oversee the equivalent of $63.2 billion from Tokyo, said in a March 25 telephone interview. “It’s not a self-expanding economy. They Fed will keep doing quantitative easing. Money will be coming into Treasuries.”
Even as the Fed has expanded its balance sheet to a record $3.2 trillion, its preferred measure of inflation, the personal consumption expenditures index, which measures household spending, rose 1.2 percent in January from a year earlier, the Commerce Department said March 1. That was the smallest increase since October 2009 and down from a recent high of 2.9 percent in September 2011. Faster inflation erodes the value of bonds.
Strategists at Bank of America Merrill Lynch forecast the Fed will buy $540 billion in Treasuries this year, and that foreign holdings, which rose by $566.4 billion, or 11 percent, in 2012, will match or exceed that total.
That projects to $1.106 trillion in demand from the two largest constituent buyers this year, or $123 billion more than the firm’s forecast for net government debt supply.
“What matters for Treasury yields is the behavior of these two biggest holders of the market, foreign investors and the Fed,” Shyam Rajan, an interest-rate strategist at Bank of America Merrill Lynch in New York, another primary dealer, said in a March 25 telephone interview. “If they continue buying at the same pace, then we still have a supply shortage in the Treasury market.”