Foreign Grip Loosens on U.S. Treasuries

U.S. investors take up the slack as China and Japan slow purchases of Treasury bonds.

Overseas creditors such as China and Japan enabled the U.S. to spend its way out of the recession as they gobbled up 80 percent of the nation’s Treasuries. Now, their holdings are dropping toward the lowest level in a decade, while homegrown investors have picked up the slack.

Excluding Treasuries held by the Federal Reserve, U.S. investors such as mutual funds and pensions have boosted their stakes in the nation’s long-term interest-bearing debt securities since the credit crisis to 33 percent, according to the latest government data. With foreigners buying the fewest Treasuries last year since 2006, domestic buyers have added $33 billion of bonds, according to JPMorgan Chase & Co.

“Domestic bidders are stepping in as foreign bidders are stepping out,” William O’Donnell, the head U.S. government bond strategist at RBS Securities Inc., one of the 22 primary dealers that are obligated to bid at debt auctions held by the Treasury, said in a telephone interview from Stamford, Connecticut.032414

Foreigners are slowing their purchases of U.S. government debt as central banks and reserve managers tried to diversify away from dollar-based assets on speculation the Fed’s policy of printing money by buying bonds would debase the greenback. Among fixed-income investors in the U.S., Treasuries are gaining more favor as the extra yield provided by bonds of the most-creditworthy companies dwindles to the least since 2007.

With the Fed moving to end its own debt purchases this year, the willingness of U.S. investors to finance a greater share of America’s $12 trillion in marketable debt securities is now providing a crucial source of demand.

Becoming less beholden to foreign creditors also means the U.S. can limit the risk any reduction in their buying will trigger a sudden surge in borrowing costs for the government, companies and consumers.

Yields on 10-year Treasuries, a benchmark for everything from mortgages to car loans and corporate bonds, have confounded forecasters by falling this year as an economic slowdown in China and political crises from Thailand to Ukraine helped fuel demand for the safest assets among U.S. investors.

After reaching a 29-month high of 3.05 percent at the start of the year, yields on the benchmark 10-year note ended at 2.74 percent last week. That compares with an average of 4.7 percent in the past two decades and 5.84 percent for past 30 years. The yield was 2.77 percent as of 7:21 a.m. in New York.

 

Foreign Holdings

Of the $8.1 trillion in U.S. government notes and bonds not held by the Fed, overseas investors owned $5.4 trillion as of January, data from the Treasury department and the central bank compiled by Bloomberg show. The figures exclude Treasury bills, which have maturities of one year or less.

The total is equal to about 67 percent, approaching the lowest level since the government began releasing the data in 2000. Overseas investors scaled back their pace of U.S. debt purchases last year, increasing their holdings by $228.2 billion, or 4.1 percent, the least in seven years.

China, the largest foreign creditor with $1.27 trillion of Treasuries as of January, has slowed its accumulation to about 3.1 percent annually since 2010. That compares with an average yearly increase of 34 percent in the 10 years before.

The reduction in buying comes amid concern that the Fed’s stimulus, which has flooded the U.S. economy with more than $3 trillion since 2008, will accelerate the dollar’s weakness against the yuan and deepen losses on its foreign-currency assets.

The People’s Bank of China said in November the nation doesn’t benefit anymore from boosting those holdings.

“It’s no longer in China’s favor to accumulate foreign-exchange reserves,” Yi Gang, a deputy governor at the central bank, said in a speech in November organized by China Economists 50 Forum at Tsinghua University.

China’s foreign-currency holdings stood at $3.8 trillion—more than triple any other nation and bigger than the gross domestic product of Germany, Europe’s largest economy. Since China’s 2005 decision to let its currency float within a restricted band set by its policy makers, the dollar has fallen in eight of the past nine years against the yuan.

 

Default Risk

Japan, the second-largest foreign lender, has expressed concern that repeated debates in the U.S. Congress about whether to raise the debt ceiling may risk a default and damage the value of its $1.2 trillion of Treasuries.

During the last standoff in October, which caused a 16-day U.S. government shutdown, Japanese Finance Minister Taro Aso said its nation must consider the impact of a possible U.S. default on its bond holdings, calling it a “big issue” for Japan.

In the past two years, Japan has added fewer Treasuries on a percentage basis than at any time since 2007.

At the same time, U.S. debt investors are gravitating toward longer-term Treasuries. The shift in favor of Treasuries among U.S. bond buyers has occurred this year as yields on the highest-rated company bonds have fallen to a level that doesn’t justify the additional risk, said Thomas Graff, who manages $3.6 billion of fixed-income assets at Brown Advisory Inc.

The extra yield that investment-grade corporate notes in the U.S. provides over Treasuries fell to 1.21 percentage points last week, the lowest since July 2007, data compiled by Bank of America Merrill Lynch show. That’s less than half the post-crisis peak of 2.72 percentage points in October 2011.

“We probably have a higher Treasury allocation in our primary strategies than at any time since the crisis,” Graff said in a telephone interview from Baltimore. Investment-grade bond yields have “pushed the boundaries of reason. It’s hard to find value other places.”

Bond mutual funds in the U.S. have already attracted at least $33 billion this year, making individuals a likely source of this year’s rally in Treasuries, an asset-allocation analysis by New York-based JPMorgan released March 14 showed.

 

‘Continued Appetite’

U.S. pension funds controlling $16 trillion are shifting out of equities and into government bonds as last year’s advance in American equities, the biggest since 1997, helped them slice their funding shortfalls.

With pension-advisory firm Milliman Inc. estimating the 100 biggest U.S. corporate pensions are 95 percent funded, on average, the funds are buying long-term government bonds to match liabilities and eliminate the risk of future deficits.

“There’s going to be continued appetite” for the longest-dated Treasuries, Steven Center, a fixed-income consultant at Callan Associates, an adviser to pension funds with a combined $2 trillion, said in a telephone interview from San Francisco.

U.S. government debt that matures in 10 years or more have returned 6.1 percent this year, their best start since 2000, index data compiled by Bank of America show.

The rise in domestic ownership may be helping dispel concern that overseas creditors are gaining too much influence over America’s finances, said Michael Materasso, co-chairman of the fixed-income policy committee at Franklin Templeton Investments, which oversees $320 billion of bonds.

After the financial crisis, the U.S. budget deficit surpassed $1 trillion for four straight years as the government boosted spending to bail out the nation’s banks and revive the economy hobbled by its worst recession in seven decades.

The nation’s debt burden soared, and China surpassed Japan to become the largest foreign creditor to the U.S. as their combined holdings surged to $2.5 trillion.

 

Political Issue

Foreign ownership of U.S. debt became an issue in the last presidential election as Republican candidate Mitt Romney said in August 2012 that borrowing a trillion dollars from China to finance more spending was unsound policy.

There used to be “this constant focus on the expansion of the Treasury holdings held by China,” Materasso said by phone from New York. “It doesn’t seem to be as much of a focus.”

Foreigners own more than twice as much as long-term government debt as U.S. investors, meaning the largest creditors such as China still have the ability to sway perceptions, said Jason Rogan, managing director of U.S. government trading at Guggenheim Securities LLC, a New York-based brokerage for institutional investors.

“They still are a very important factor in the market,” he said in a telephone interview. “You’d rather jump on board with them than get run over by them.”

Fed Chair Janet Yellen also rattled bond investors after saying on March 19 that the central bank’s benchmark interest rate, which has been close to zero percent since 2008, may rise about six months after it stops buying bonds. Yields on all government securities surged last week, with those on the two-year note soaring by the most since June.

The Fed has cut purchases of Treasuries and mortgage-backed debt by $10 billion at each of its past three meeting this year and economists in a Bloomberg survey forecast the bank will end its monetary stimulus by year-end.

Since starting its third round of quantitative easing in September 2012, the central bank has bought $655 billion of Treasuries, data compiled by Bloomberg show.

It’s “a real problem,” according to Aaron Kohli, a New York-based interest-rate strategist at BNP Paribas SA.

Even though foreigners have slowed their purchases of U.S. debt, there are few if any signs of an outright exodus.

 

Haven Demand

On an absolute basis, Treasuries held by overseas investors rose to a record $5.83 trillion in January as turmoil in emerging markets fueled demand for haven assets.

“You need something in your portfolio that’s going to be defensive because you never know where the next stress point is,” Jack McIntyre, a money manager who oversees $45 billion at Brandywine Global Investment Management LLC, said in a telephone interview from Philadelphia.

America’s improving fiscal balance means the government can finance its spending without issuing as much debt.

Stronger economic growth and spending cuts have narrowed the U.S. budget deficit to a seven-year low of $680.2 billion last year, equal to 4.1 percent of the economy. That compares with more than 10 percent in 2009. The Congressional Budget Office forecasts the shortfall will drop about 3 percent this fiscal year, close to average over the past four decades.

The U.S. current account, which measures the total imports and exports of goods, services and financial transfers, narrowed 14 percent to a deficit of $379.3 billion in 2013, the least since 1999, the Commerce Department said March 19.

“Things feel much better than they did five years ago,” Shyam Rajan, an interest-rate strategist at primary dealer Bank of America Corp., said by telephone from New York.

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