Hedge funds are increasingly tying the fortunes of U.S. bonds to the rest of the world, which suggests that Treasury yields will stay low—or go even lower—in the near term.
These investors probably increased their Treasury holdings to record amounts over the past year. This is significant because these funds generally trade securities more frequently than sovereign wealth funds or central banks, which may make the debt more volatile day to day.
Hedge Funds' Total Assets Under Management: $2.9 Trillion
This isn't a completely surprising development: Hedge funds have more than doubled their assets under management since 2008 and now manage a record $2.9 trillion of assets, according to Hedge Fund Research. They need to find places to invest that money at a time of slowing growth and unfathomably low bond yields in Japan and Europe.
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Hedge funds apparently saw a bargain in U.S. debt over the past year as commodity-dependent nations and China liquidated their holdings of the notes to support their markets and economies. In all likelihood, the funds mitigated the technical effects of such significant selling.
The shift does, however, underscore the degree to which the world's biggest debt market has been transformed in the past few years. Treasuries have gone from being basic staples for big buy-and-hold investors to opportunistic wagers for algorithms and relative-value traders.
And if you pit U.S. government bonds against other developed-market sovereign debt, Treasuries look great by comparison. Take a look at 10-year U.S. bonds: They yield 1.9 percent, almost 2 percentage points more than rates on similar-maturity Japanese debt and 1.7 percentage points more than similar German notes. Of course, bond buyers also must take into account currency fluctuations and the cost of hedges to eliminate this risk when thinking about relative value between these different types of debt. Sill, it's hard to see how U.S. Treasury yields can surge if hedge-fund investors are looking for bargains around the world.
About 70 percent of Japan's government bonds now carry negative yields, according to Bloomberg News reporters Kevin Buckland, Shigeki Nozawa, and Yumi Ikeda. Even yields on some European corporate debt have fallen below zero as the region's central bank embarks on a plan to buy higher-rated company bonds.
There is a risk that greater ownership of Treasuries by hedge funds will make the U.S. bond market more volatile. These funds tend to use leverage to amplify returns, and a wrong-way bet can lead to more pronounced price jumps.
But there's also the possibility that the Fed data, which puts hedge funds under the rather all-encompassing and rather misleading category of "household and non-profit organizations," isn't totally reliable as a gauge of fast-money investments in Treasuries.
"Our sense is that the Treasury monthly flow data are not necessarily calibrated to pick up that direct, real-money investment from overseas," said Jim Vogel, an interest rate strategist at FTN Financial. In other words, the rapid increase in Treasury holdings being attributed to hedge funds may also include foreign investors racing to the U.S. to escape ever-lower bond yields in their home countries. As long as yields stay so incredibly low around the world, it's hard to see what would prompt these Treasury owners to sell in a wholesale fashion without other buyers stepping in.
That means while hedge funds could introduce more day-to-day unpredictability into in the Treasury market, over the long term they are unlikely to roil the low yields that are sweeping the globe.
This column does not necessarily reflect the opinion of Bloomberg LP and its owners.
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