US Treasury Securities Are Truly an International Asset Now. In understanding what is going on in this market for Treasury securities you have to have some idea of how funds are flowing internationally.
In my post last week, I discussed (briefly) how lots and lots of risk averse money flowed from Europe into the United States Treasury securities…a safe haven…during the financial disturbance in the eurozone from 2011 into the middle of 2013.
To see a list of high yielding CDs go here.
One impact of this flow was the drop in the yield of the 10-year US Treasury Inflation-Protected securities (TIPS). In the latter part of March 2011, the yield on the 10-year TIPs was 1.0 percent.
In the middle of August 2011, this yield hit 0.0 percent as funds flowed into the United States from Europe. The yield remained negative until the first week of June 2013. By the end of June 2013, the yield was up to around 0.5 percent.
During this time period, the amount of the public federal debt held by foreign and international investors jumped from 31.5 percent of Gross Domestic Product in the third quarter of 2011 to 34.6 percent in the first quarter of 2013. This was an increase of over 3 percentage points, representing a huge flow of funds into the United States to buy Treasury securities.
And, this flow of funds had a major impact on United States interest rates, something that had never happened before.
So, to understand what is going on in the United States bond markets, an investor must have some understanding of who is holding US Treasury securities and how funds are flowing internationally.
This is particularly important at this time as the Federal Reserve system brings quantitative easing efforts to an end with the close of its ‘tapering’ of security purchases. It is important because of what might happen with interest rates as the Federal Reserve changes its operating goals.
At the end of the first quarter of 2014, the total debt of the United States was $17.6 trillion. Note that the nominal Gross Domestic Product of the United States is $17.0 trillion. Of this $17.6 trillion, $12.6 trillion or roughly 72 percent of the debt is held in the hands of the public. Therefore, 28 percent of the debt, or about $5.0 trillion, is held by Agencies and Trusts of the government.
As of April 2, 2014, the Federal Reserve held $2.3 trillion of the Treasury securities outstanding.
A further breakdown indicates that Foreign and International Investors hold $5.9 trillion of the $12.6 trillion of debt held by the public.
I don’t have data that are exactly comparable to what I have been presenting, but Treasury data as of May show that “foreign official entities” held $4.1 trillion of US Treasury securities. Breaking this down even further, we find that in May China held about $1.3 trillion in Treasuries and Japan held about $1.2 trillion.
It has also been noted that there has been a growing taste for these foreign holders to invest in longer-dated maturities.
This is just a part of the information needed to try and get a hold on Treasury yields and what might happen to them over the next year or so as the Federal Reserve moves on into the post-quantitative easing period.
For example, last year, many analysts believed that longer-term Treasury yields were going to rise into 2014 and that by the end of the year the interest rate on, say, 10-year Treasury notes would rise to maybe 3.50 percent or higher as the Federal Reserve stopped its policy of quantitative easing.
On December 31, 2013, the 10-year Treasury closed to yield 3.03 percent.
Well, by March 31, 2014, the 10-year closed to yield 2.72 percent. On June 30, 2014, the yield was 2.58 percent. And, as of the close of business on July 23, 2014, the 10-year closed to yield 2.47 percent.
After acquisitions of US Treasury debt by foreign interests dropped in the second quarter of 2013, funds started to return to the Treasury market in the third and fourth quarter and into the first quarter of 2014. A lot of money apparently came into the US market from China and Japan.
International flows of funds are more important now than ever before.
And, this is what analysts are concerned about in looking forward. What is going to influence foreign flows of money in the future because this is going to have an impact on the direction of interest rates regardless of exactly what the Federal Reserve does. In essence, the Federal Reserve does not have as much influence over interest rates in the United States, particularly longer-term interest rates, as it once did.
So, what are some of the questions one needs to ask?
For one, there is the question of how long will foreign demand continue for US Treasury securities? “Sentiment may be tested once the Fed ends QE as planned in October and net issuance of Treasury debt starts rising after a contraction earlier this year.”
In addition, the Treasury is “looking to extend the maturity of its outstanding debt and the US budget deficit is projected to grow from 2016…” and the Fed won’t be there to absorb a lot of it.
Furthermore, other countries have their own concerns. For example, China is facing several issues like an overvalued currency and an accompanying balance of payments issue. It may have to engage in economic policies that might make it less of a holder/buyer of US Treasury securities in the near term and this might negate some of the effort that the Fed is making to end quantitative easing.
Then there is the continued financial market dislocation in Europe. And, so on and so forth.
Never before has the US bond market been so impacted by foreign flows of money. Because of this, understanding market movements in yields has become that much more difficult, let alone the problems that this situation causes investors in trying to predict where interest rates are going to go.
This situation will only become more complex as the twenty-first century moves along.
About John Mason John has been the President and CEO of two publicly traded financial institutions and an Executive Vice President and CFO of a third. He has also spent time as an economist in the Federal Reserve System and worked for a cabinet secretary in Washington, D. C. In addition John taught in the Finance Department at the Wharton School of the University of Pennsylvania for ten years. He now currently has a column on the blog Seeking Alpha and is ranked number 3 in terms of readers on the economy. From this column, two books have been published this past year from earlier blog posts. John is active in the shadow banking world, the venture capital space, and in angel investing. Other than that John works with start ups and early stage organizations, for profit and not-for-profit.