AAA Shortage Drives Foreign Treasury Holdings to Record $5 Trillion

Monday, 05 Mar 2012 11:14 AM

 

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For all the concern that the $10 trillion market for Treasurys is dependent on Federal Reserve purchases to absorb a continually expanding supply of debt, the amount held by investors outside the U.S. has grown even more.

Foreigners increased their holdings of U.S. government debt by $1.84 trillion to a record $5 trillion since the Fed began the first round of Treasury purchases in May 2009, taking their stake to 60.5 percent of the securities not held by the central bank, government data show. The Fed added $1.18 trillion during that period, to $1.65 trillion, or 16.8 percent of the total, from 7.6 percent.

International buying underpins President Barack Obama’s financing of a budget deficit forecast to exceed $1 trillion for a fourth year. Ten-year note yields stuck below the rate of inflation have caused hedge fund manager Leon Cooperman to shun the debt. At the same time, the risk of declines have been limited by the shrinking supply of AAA rated alternatives.

“There are buyers that lurk everywhere,” said William O’Donnell, head U.S. government bond strategist at RBS Securities Inc. in Stamford, Connecticut, one of 21 primary dealers that trade with the Fed, said in a Feb. 29 telephone interview. “There’s plenty of cash out there that would love to get its hands on quality assets at a reasonable rate. The problem is, there’s not enough high-quality liquid bonds.”

European Holdings Rise

Ten-year Treasurys have lost 0.3 percent and U.S. government securities of all maturities are down 0.3 percent in 2012 after 10-year debt gained 17 percent and the broader market returned 9.8 percent in 2011, according to Bank of America Merrill Lynch bond indexes. Investors continue to pile into U.S. assets amid concerns about the outcome of the Europe debt crisis and the pace of the U.S. recovery.

Treasurys were steady last week, with 10-year note yields unchanged at 1.98 percent. The benchmark 2 percent security due February 2022 was unchanged at 100 7/32. The two-year note yield fell 3 basis points to 0.27 percent.

Ten-year notes yielded 1.97 percent, and two-year rates were little changed today as of 9:35 a.m. London time.

International holdings increased 13 percent in 2011, led by Europe, as investors sought safety from declining sovereign credit quality. Luxembourg increased its stake by 74 percent in 2011 to $150.6 billion, Switzerland boosted its amount 33 percent to $142.5 billion and Belgium’s position in the debt more than quadrupled to $135.2 billion, according to data released by the Treasury Feb. 29.

Funding the ‘Parasite’

The U.S. dollar’s share of global foreign-exchange reserves climbed in the third quarter to 61.7 percent, the highest since late 2010, while holdings of euros fell to a three-year low of 25.7 percent, according to quarterly figures from the Washington-based International Monetary Fund.

“They’re looking for safety and liquidity,” Carl Lantz, head of interest-rate strategy in New York at primary dealer Credit Suisse Group AG, said in a Feb. 29 telephone interview. “There hasn’t been a credible alternative to the dollar presented.”

Russia increased its stake in Treasurys to $149.5 billion, an 8.3 percent advance since August, when Russian Prime Minister Vladimir Putin called the U.S. a “parasite” because he said its rising debt is weighing on the global economy.

European gains helped make up for the decline in holdings by China, the largest foreign lender to the U.S. The world’s second-largest economy cut its Treasurys 12 percent to $1.15 trillion from a peak of $1.31 trillion in July.

Japan’s U.S. government securities rose 20 percent to $1.06 trillion in 2011, its fourth consecutive annual increase.

‘Most Dangerous’

Cooperman, 68, founder of equity hedge fund Omega Advisors Inc., said Feb. 22 in an interview on Bloomberg Television’s “InsideTrack” with Erik Schatzker that buying Treasurys is the least attractive investment and the worst place to put money for the next three years. Warren Buffett, 81, the billionaire chairman of Berkshire Hathaway Inc., said in his annual letter to shareholders that bonds and other holdings tied to currencies “are among the most dangerous of assets.”

The 10-year Treasury yield will rise to 2.5 percent by the end of 2012, according to the average of a Bloomberg News survey of 78 forecasters. A climb to that level would leave buyers with a 3 percent loss at year-end, according to data compiled by Bloomberg.

While outstanding U.S. public debt expanded to $9.94 trillion in December from $6.27 trillion since March 2009, Fed and Treasury data show last year’s 13 percent rise in Treasury holdings by foreigners to $5 trillion was the least since 2007.

Shrinking Supply

The supply of AAA rated assets globally has declined about 2.6 percent since peaking in April at $18.8 trillion according to the Barclays Capital Global Aggregate Bond Index. A Bank of America Merrill Lynch index shows the number of issues in its AAA index fell to 3,611 from 5,331 in 2007.

Net U.S. fixed-income issuance, including everything from Treasurys to corporate bonds to mortgage-backed securities, is forecast to fall to $520 billion this year from $1.2 trillion last year and $2 trillion in 2010, according to a Jan. 6 Credit Suisse report. The bank’s U.S. interest-rate strategists forecast net borrowing will rise to about $967 billion in 2013.

‘Ultimate Safe Haven’

The debt crisis that started in Greece, Portugal and Ireland before engulfing Spain and Italy has ratcheted up pressure on the wealthier members of the euro zone. France was downgraded to AA+ by Standard & Poor’s on Jan. 13 while investors snubbed AAA rated Germany Nov. 23 when it was able to sell only 65 percent of a 6 billion euro debt offering.

“Treasurys represent the ultimate safe-haven asset, particularly at a time when investors have been concerned about the dynamics in Europe,” Mark Dowding, a senior money manager at Bluebay Asset Management Ltd. in London, which manages $39 billion in fixed-income assets, said in March 2 telephone interview. “We would argue that Treasurys offer a safer haven than German bunds, for example, in as much as if Europe really does hit the skids,  Germany will end up paying.”

The cost to insure against the risk of a U.S. default in the next five years has dropped to 35 basis points from 56.3 basis points on Aug. 8, following the decision by Standard & Poor’s to lower America’s credit rating to AA+, according to CMA prices. Protecting against a default by Germany over the same span has fallen to 76 basis points from 79 basis points.

Quantitative Easing

Last year’s $566.2 billion in purchases were the fewest since 2007 when international investors bought $250.1 billion of the debt, Treasury data show. Foreign holdings jumped 20 percent in each of 2009 and 2010 and 31 percent in 2008.

The Fed said Sept. 21 that it would replace $400 billion of shorter-maturity Treasurys in its holdings with longer-term debt to contain borrowing costs.

The central bank has made $226.2 billion of those purchases, which are scheduled to run through June.

“The driver of low yields today is more Fed action and policy than foreign investing,” Krishna Memani, director of fixed income at OppenheimerFunds Inc. in New York, who helps manage $70 billion, said in a Feb. 29 telephone interview. “That’s really the primary driver of yields rather than what China is doing.”

After buying $2.3 trillion in bonds including $900 billion of Treasurys in two stages of so-called quantitative easing ending in June, the Fed has kept its holdings steady at $1.65 trillion.

The central bank said in its Jan. 25 statement that the economy is “likely to warrant exceptionally low levels for the federal funds rate at least through late 2014.”

Unemployment Falls

Fed Chairman Ben S. Bernanke said in testimony before the House Financial Services Committee on Feb. 29 that, while there have been “positive developments” in the labor market, it “remains far from normal.”

More than 3.6 million private sector jobs have been added since the end of 2009, while government employment has dropped by 506,000 Labor Department data show.

Unemployment dropped to 8.3 percent in January, the lowest since 2009, and initial jobless claims fell to 351,000 for the week ended Feb. 25, the fewest since March 2008. Still, the improvements have yet to spur wage inflation, as average hourly earnings rose 1.9 percent in January, the smallest increase since April, and down from 3.2 percent in 2008 and 3.7 percent in January 2009, Labor Department data show.

Foreign ownership of all public U.S. government debt has held above 50 percent since September, according to the Treasury’s revised data. At 50.3 percent as of December, overseas holdings have risen from 48.4 percent in June, the lowest since November 2006.

Foreign buyers have “clung on to purchasing Treasurys even as the Fed sucked most of them out,” Dominic Konstam, head of interest-rate strategy at primary dealer Deutsche Bank AG in New York, said in a Feb. 27 telephone interview. “Everyone’s getting crowded out to some extent, including foreign officials.”

© Copyright 2014 Bloomberg News. All rights reserved.

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