Wednesday, January 20, 2010

That Unflagging Demand for Treasuries

When the Fed's program to purchase a total of $300 billion of Treasury securities ended in October, concerns were raised that the removal of a major buyer supporting the market in the previous six months or so would tend to cause a setback for long-term yields. Those concerns were actually compounded by growing signs of an economic recovery taking hold- a dynamic that would have also been expected to push yields higher.

In fact, the Treasury market did come under pressure in the period from mid- November to late December, with long-term yields rising by more than 50 basis points. But the back-up in yields was most certainly of the moderate kind (not of the-end-of-the-world-as-we-knew-it kind), indicating that there was a potent underlying force that was offsetting the adverse dynamic of an economic recovery, large Treasury issuance, and the end of the Fed's program of Treasury purchases. Since then, yields have actually come off by about 20-25 basis points, with the 10-year note trading at around 3 5/8% again.

So, someone out there is clearly buying Treasuries.

The TIC (Treasury International Capital System) data for November 2009, released earlier this week, provide very useful insight regarding that question, as they showed a record $118.0 billion of net purchases of long-term Treasuries by foreigners during that month. This overshadows the previous record of slightly over $100 billion reported for June of last year.

Net Foreign Purchases of Long-Term Treasuries

Source: Action Economics

Contrary to the often popular perception that buying by foreign central banks is the primary factor supporting the U.S. Treasury market, such purchases represented actually a relatively small share of the overall amount in November. Foreign official institutions accounted for approximately $31 billion of those purchases, with the remaining $87 billion coming from private foreign investors, which demonstrates a broad-based interest in the Treasury market by foreigners.

The seemingly ferocious demand for long-term Treasuries is also intriguing for an additional reason. Despite the massive influx of funds into emerging markets in the second half of 2009, this does not appear to have come at the expense of the demand for Treasuries by foreign investors. The explanation here is presumably that the reduction in the perception of global market risk in the second half of 2009 has triggered such an enormous exodus of funds previously parked in cash instruments that has allowed both U.S. Treasuries and emerging markets to become beneficiaries of such money being put to work again.

The TIC data are indeed very volatile on a month-to-month basis and are typically revised- often, appreciably. In that context, it would not be surprising to see a strong payback in December for the impresive strength in November's numbers regarding net purchases of Treasuries. But the key point remains undiluted: foreigners maintain a strong appetite for Treasury securities and do not seem prepared to shun that market despite the relative restoration of calm in global financial market conditions.

In other words, the Treasury market is not simply a safe haven.

Anthony Karydakis

(In a future posting, we will look in to the role of China in the overall purchases of Treasuries by foreigners).