When former Federal Reserve chairman Ben Bernanke first hinted at a possible tapering of bond purchases nearly a year ago, he triggered a rout in U.S. Treasuries that rocked financial markets around the world. Today the Fed is actually reducing its purchases of Treasuries, but many foreign central banks — including some in key emerging markets — are increasing theirs.
In 2013 foreign investors, including central banks and private investors, bought only $228.2 billion of Treasuries, increasing their holdings by 4 percent, according to numbers from Bloomberg based on Treasury International Capital (TIC) data. It was the lowest amount of foreign Treasury purchases since 2006. But in the first two months of this year, foreigners purchased $92.2 billion of Treasuries, more than a third of last year’s total, lifting their holdings by 1.6 percent in the process, according to Treasury Department data.
“Last year the main event was the talk about the Federal Reserve [tapering its quantitative easing] that generated a lot of volatility,” says Jens Nordvig, head of U.S. fixed-income research and global head of foreign exchange strategy for Nomura in New York. “Foreigners were selling bonds for a few months.” Emerging-markets central banks cut their Treasury buying as their accumulation of dollar reserves slowed last year. This too was related to the chatter over tapering. That talk depressed foreign investment in emerging markets, which meant less upward pressure on those local currencies, which in turn meant less need for emerging-markets central banks to sell their currencies for dollars.
“Normally the big currency accumulation in emerging markets came from trying to smooth the appreciation in their currencies when money was flowing in by intervening in the currency market,” says David Gilmore, a partner and economist at Foreign Exchange Analytics, a currency analysis service in Essex, Connecticut. Asian central banks had been the most active on this front, but central banks in Latin America did this too, he says.
“From May onward, you didn’t have an emerging-markets inflow,” says Priya Misra, head of U.S. rates strategy research at Bank of America Merrill Lynch in New York. Another factor weighing on foreign Treasury purchases last year was the winding down of the European financial crisis, which led foreigners to move into European debt instead of Treasuries, she says. Those moves reversed some of the flows of 2010-’11, when the eruption of the European debt crisis triggered a flight to safety in Treasuries. Finally, the reduction in the U.S. budget deficit meant that the government was issuing fewer Treasuries, which also curbed foreign demand, Nordvig says. The deficit shrank to $680 billion in the fiscal year that ended September 30, down from $1.1 trillion in the prior year.
Gilmore believes the deficit reduction will ultimately be positive for Treasuries, as it could help bolster foreign confidence in U.S. finances.
China is the largest foreign holder of Treasuries, with $1.27 trillion as of February, according to Treasury Department statistics. Its Treasury purchases have slowed to 3.1 percent a year since 2010, down from a 34 percent pace during the previous ten years, according to Bloomberg numbers based on TIC data. Nordvig says that the slowdown reflects China’s downward-trending current-account surplus, which fell to 2 percent of gross domestic product in 2013 from 6 percent in 2009. Japan is the second-biggest foreign holder of Treasuries, with $1.21 trillion as of February. In the past two years, it added the least amount of Treasuries on a percentage basis since 2007, according to TIC-data-based Bloomberg figures. Japan historically buys large amounts of Treasuries when the Bank of Japan intervenes to push down the yen, Nordvig says. But the currency fell on its own last year, so there was no need.
International buyers played a role — but not a decisive one — in the jump of Treasury yields last year. “Foreigners exacerbated the rate rise, but the comments from Bernanke are what really did it,” Misra says. As for the rise in international Treasury purchases during the first two months of 2014, foreign investors “have finally digested the news that the Fed has normalized policy,” Nordvig says. “The yield curve is sitting at higher levels [than before the tapering talk]. That’s attractive for European and Japanese investors, where yields are very low.”
China increased its Treasury holdings by $2.9 billion in January and February, according to the Treasury Department. But that may understate its buying. If China’s central bank purchases Treasuries through foreign banks, the Treasury attributes much of those purchases to foreign banks. And if the People’s Bank of China holds its Treasuries at a foreign bank, again, the holdings often get attributed to that bank. Nordvig estimates that China’s central bank bought $108 billion in an effort to depress the yuan in the first quarter. And some of those dollars found their way into Treasuries. Japan acquired $28 billion of Treasuries in the first two months of the year. Life insurance and pension funds in Japan have been buying Treasuries amid encouragement from the Japanese government.
The overall foreign buying has helped keep Treasury yields down this year, experts say. “There has been a broad-based increase in demand for Treasuries,” Nordvig says. “Foreign demand is part of that.” He says foreigners could continue to increase their Treasury purchases. “I think there will be very steady demand from Japanese investors,” he says. “That’s a multiyear trend. And with low yields in the euro zone, [even in] Italy and Spain, U.S. interest rates will look more and more attractive to foreign investors.”
But Gilmore finds it worrisome that the massive expansion of central bank currency reserves has created a vast pool of capital that can run into and out of asset markets, such as Treasuries. “When you have money washing in financial assets, there’s a much greater propensity for asset bubbles,” he says. “It facilitates a casino element of modern finance, creating financial instruments for people to express a bet, which may have nothing to do with real investment.”
See also II’s story “Deeper Bond Markets Carry a Cost for Emerging-Markets Economies.”
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