by Chris Hamilton
Given the Fed will complete its “taper” shortly…the topic of who has bought, who owns, and who will buy US Treasury debt seems a tad bit important.
The 1st slide shows the four distinct classes of US Treasury buyers. It shows who purchased and how much in each time period since ’00 cross referencing the blended interest rates on the Treasury curve. As yields have collapsed and the alternative markets (stocks, RE, corporate or junk bonds) have improved or offered more attractive returns…only the Fed and “Foreigners” have continued to seriously accumulate Treasury’s. BTW – I included the Fed’s $667 Billion in Operation Twist long bond purchases (paid for from selling all their short paper) to show the power and magnitude of the Fed’s purchases on the Note and Bond “markets” since 2011…
The next chart shows holdings of Treasury’s in ’00 versus present and in between shows each group purchases by period…notice the Fed and Foreigners coming to the fore.
By percentage of all new Treasury debt purchased by the below periods, the Federal Reserve and Foreigners bought 83% of all US Treasury debt from ’11 – present, double the % they purchased in ’00-‘07. This transfer of responsibility from US Public and Intra-Government buying is unprecedented.
OK, let’s follow CBO assumptions that debt creation will continue at present levels or slightly higher ‘til say, infinity. Who will buy the new and rollover debt? Since the yields are too low for most public pensions or insurers or institutional buyers and without a major market downturn; they are not likely to step forward. The Intra-Government purchases will be limited by slowing or negative Social Security surplus’ so no buyer there. And the Fed’s taper is nearly complete and the Fed says it will be looking to “normalize” their balance sheet by directly selling or slowly rolling off their holdings.
This leaves only “Foreigners” to maintain the Treasury bid for the vast majority of new issuance plus pick-up the Fed’s “roll-off” while simultaneously maintaining the foreign held $6+ Trillion in Treasury holdings. Ok, got it, “foreigners” have to buy the bulk of all Treasury debt to ensure America feels no pain. So, which “Foreigners” can we count on and which have been buying since 2011?
What is noteworthy about this list is that almost none of them have excess Foreign Exchange Reserves with which to purchase the US Treasury’s. And note below those running surpluses are net sellers (UK is typically a false front for Chinese purchasing or selling).
And what happened since the Fed’s December ’13 Taper announcement and their now almost entirely tapered purchases (taper = reduction of monthly Treasury and Mortgage Backed Securities from QE3 peak of $85 B/mo to present $15 B/mo…and by year-end to zero)? Yields collapsed!!!
But if not the Fed buying, who did? Well, Belgium and the Cayman Islands became our 3rd and 4th largest creditors…two “nations” without any foreign exchange reserves in need of recycling while those (China, Russia) with reserves and continuing surplus’ are selling??? Curious.
This would seem to imply America has 3 basic options to avoid an interest rate shock on its $17.8 Trillion in debt and more broadly continue its low-interest rates supporting its interest sensitive economy (housing market, stock buybacks, car loans, etc., etc.).
1- Belgium, the Cayman Islands, Luxembourg, Ireland, and the like nations continue to “buy” US Treasury’s with dollar reserves they don’t have?!? If nobody has questioned this one so far, maybe they never will???
2- The Fed backtracks on its taper and re-initiates the printing presses. Seems Fed has carte blanche to monetize as they see fit???
3- Markets collapse making Treasury’s once again the “safety” bid. This seems the likeliest scenario if neither of the two above options are employed to maintain the Treasury market from ’15-’18.
Let’s take a quick look at what this last scenario looks like just to play out the Federal Reserves thinking:
• Let’s assume debt creation continues at current levels
• Intra-Government and Foreigners continues buying at current levels• If we take the Federal Reserve and chairperson Janet at their word, the Fed will complete its taper in ‘14 and roll off up to 1/3 ($800 B) of its Treasury holdings over the ’15-’18 period in a process of balance sheet “normalization”
• This leaves the domestic “Public” (Pensions, Insurers, Institutional buyers) in need of increasing their purchases by a factor of 10x or finding an extra $2.2 trillion over their ’11-’14 purchases to make up for the shortfall. Heck, even if the Fed continues to roll all its Treasury holdings, the Public still has to come up with $1.6 trillion over the ’15-‘18 period.
This below scenario of Public domestic buyers purchasing massive Treasury holdings would mean equal massive selling of existing assets on hand…i.e., stocks and non-sovereign bonds. Not exactly a pretty picture for financial asset prices which the Fed worked so hard to boost.
Bottom line, the Federal Reserve created false demand for real debt created by the Treasury…and now the Federal Reserve wants to pretend it can step aside for a real buyer somewhere out there for all this debt.
Article written by Chris Hamilton. You can also find his work at CharlesBiderman.com.
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