The US Treasury has more than just the Federal Reserve in its corner as it battles to contain the cost of financing the nation’s record budget deficit.
American money-market funds – a harbour for the assets of retirees and companies – have bought the brunt of the roughly $2.2 trillion (Dh8.08tn) in bills the government has sold to raise cash for economic stimulus amid the pandemic. The Fed has bought almost none, instead hoovering up hundreds of billions of dollars of notes and bonds.
It’s the latest case of domestic private investors stepping up in the face of a decade-long retreat in foreign demand, which may struggle to rebound significantly given the US’s diminished yield advantage.
Of course, treasuries will always benefit from their premier haven status, with last week’s 10-year auction selling at a record-low yield. But with the US issuing a mountain of debt across maturities, the appetite of homegrown buyers is crucial.
“If the US money-fund industry wasn’t so large, there’d be some possibility that the market wouldn’t be able to absorb all the new Treasury issuance that we’ve seen in such a short period,” said Peter Yi, director of short-duration fixed income and head of credit research at Northern Trust Asset Management.
The US government is on track to issue an unprecedented wave of nearly $5tn in net new debt in 2020 to plug an exploding budget gap. Assets in US money-market funds have surged as well. They hold a near-record $4.7tn as investors have sought shelter amid uncertainty over the pandemic’s economic toll.
“Treasury bills are an attractive option for us,” said Kevin Gaffney, chief investment officer of money markets at Fidelity Investments, which oversees $3.3tn of assets. “They’re very liquid, safe and their yields have been attractive relative to other government products such as agencies and repo.”
But domestic demand doesn’t protect the bond market from broader volatility. March delivered a taste of what happens when investors pull back. Foreigners unloaded a record amount of Treasuries – almost $300 billion.
The Fed stepped in to calm markets as yields soared with investors globally rushing to raise liquidity. The central bank launched a plan to buy $75bn of Treasuries a day temporarily. It’s now purchasing $80bn a month, and is set to buy $2.5tn of Treasuries this year.
“We saw what happened in March – yields did rise when foreigners were selling, and then we saw the Fed step in, and the Fed bought more than the rest of the world sold,” said Brad Setser, senior fellow at the Council on Foreign Relations and a former economist at the Treasury.
China, the second-largest foreign holder of US government debt, has been shrinking its pile. And for foreign investors broadly, Treasuries may not be attractive hedged or unhedged. The 10-year yield is now about 60 basis points higher than its Japanese counterpart, for example. The gap was above 300 basis points in 2018.
“The overall carry that you capture from US bonds has really disappeared,” said Kathryn Kaminski, chief research strategist and portfolio manager at AlphaSimplex Group.
One looming risk is that even domestic buyers may not be able to keep up with the swelling issuance. That’s one reason JPMorgan Chase sees 10-year yields creeping up to 1 per cent by year-end, from about 0.6 per cent now.
The reason why the Treasury is issuing so much debt is because the economic troubles are comprehensive
Mark Spindel, chief investment officer, Potomac River Capital
But it sees demand from money funds, banks, insurance companies and the Fed mostly keeping yields in check, especially given policy rates are near zero and tame inflation.
“Even though there is a little bit of demand gap, when you look at drivers of rates over a longer period of time– it’s the market’s outlook for the Fed and inflation expectations that matter a lot more,” said Jay Barry, a strategist at JPMorgan.
The question in the second half of 2020 is how much the Fed might need to step up again, with the virus raging in some states, a new US fiscal package possibly in the works and strategists expecting the Treasury to shift more issuance to coupons.
What it boils down to is that unless the trend of stagnant foreign demand reverses, domestic buyers, including pensions and insurers, will be pivotal to handling the increased supply.
Last month’s 10-year note auction was a case in point: International buyers accounted for less than 10 per cent of demand, while domestic investment funds took almost half.
“I like the long end of the Treasury market,” said Mark Spindel, chief investment officer at Potomac River Capital in Washington. “The reason why the Treasury is issuing so much debt is because the economic troubles are comprehensive. And simple ‘Bonds 101’ – that’s bullish.”
Updated: July 12, 2020 09:04 PM