Would Someone Please Buy US Treasury Bonds? (#GotBitcoin?)
The erosion of demand in emerging Asian markets reflects their maturation into more stable economies.
Asian investors are proving less and less eager to buy U.S. government bonds, even as the Treasury Department prepares to sell $1.3 trillion of new debt in the new fiscal year.
Foreigners increased their holdings of Treasurys by $78 billion in the first eight months of this calendar year, according to the Treasury. That is just over half of what they bought in the same period last year.
Holdings have particularly stagnated in a number of emerging Asian economies—including South Korea, Singapore, Thailand and Taiwan—which have prized U.S. government debt as a capital bulwark since the 1997 Asian currency crisis.
Many observers assume the U.S. has no trouble finding demand for its debt in the vast pool of world-wide governments, financial institutions, mutual funds and individual investors who want to own the world’s major risk-free asset. Yet the Treasury is finding fewer buyers in some parts of the world, leaving domestic investors such as mutual funds to pick up the slack.
Much of the drop-off in demand among investors in Europe and Japan is due to the increased cost of protecting themselves from the currency risk of buying dollar-denominated debt. For emerging Asian economies, the reasons are different: Stagnant trade flows and strong reserve balances have sapped their demand for U.S. government debt, according to analysts.
The erosion of demand in these emerging markets also reflects their maturation into more stable economies where investors have a greater array of domestic investments in which to place their money.
“They don’t need to build any more buffers,” said Tim Alt, who manages currencies and bonds with U.K.-based Aviva Investors. They “have an alternative where you don’t have to recycle everything into U.S. Treasurys.”
The lack of demand doesn’t reflect a critique of U.S. fiscal policy but is more likely an indirect byproduct of U.S. trade tensions with China, according to Torsten Sløk, chief international economist at Deutsche Bank Securities. China is the world’s second-largest economy and the region’s largest trading partner for many countries, so weakness in its currency, the yuan, also has weighed down the currencies of many of its neighbors. In other circumstances, these countries could harbor more demand for U.S. debt, but currently lack a compelling need to buy it, he said.
The Treasury data could understate demand from private investors in Asia, such as insurance companies, because they often make purchases through intermediaries in other countries, according to Brad Setser, an economist at the Council on Foreign Relations. However the most important detail about demand from the region is the lack of intervention by central banks, he said.
Since the start of June, when the U.S. first imposed tariffs on China, Korea’s currency, the won, has dropped 3.3% against the dollar, while the Singapore dollar has declined 2.7%, Thailand’s baht has fallen 2.4% and the Taiwan dollar has slipped 2%. Those moves compare with a 7.1% loss in China’s yuan.
The declines in Asian emerging markets’ currencies have helped their exports remain competitive versus China, but they also have reduced the need for them to buy Treasurys—a popular way for central banks to weaken their currencies against the dollar, Mr. Sløk said.
While it is unclear whether the reduction of Treasury purchases is a deliberate decision or simply free markets at work, the lack of demand shows trade tensions between the U.S. and China have been “spilling over” into the rest of Asia, Mr. Sløk said.
Bond Indexes Bend Under Weight of Treasury Debt
The U.S. government is selling $129 billion of notes this week, up 28% from the same series of auctions a year ago.
The surge in U.S. government borrowing is beginning to warp bond indexes, posing a challenge for investors looking for the best returns when interest rates are rising.
The problem: Treasurys tend to offer investors lower yields and produce weaker returns than other kinds of bonds, such as high-quality company debt or securities backed by mortgage payments. Yet as the government steps up borrowing to fund last year’s tax cuts, index funds end up holding more Treasurys, squeezing out the securities that pay higher rates of interest.
The U.S. government is borrowing $129 billion this week, up 28% from the same series of note auctions a year ago. The increased borrowing means Treasurys now amount to almost 40% of the value in the leading bond market investment benchmark—the Bloomberg Barclays U.S. aggregate index—which fund managers use to gauge their success. That is up from around 20% in 2006, before the start of the financial crisis.
Some analysts said investors should consider the growing weight of Treasurys in indexes before purchasing mutual funds. Actively managed bond funds have performed better than their index-tracking peers recently, a trend some analysts credit to their efforts to pare back Treasury holdings. Rising rates erode the value of outstanding bonds, because newly issued debt offers higher payouts. And Federal Reserve officials have penciled in additional increases into 2020.
“The value from active management is going to be more important,” said Kathleen Gaffney, director of diversified fixed income at Eaton Vance , who bought dollar-denominated corporate bonds in emerging markets because U.S. corporate yields remain low by historic measures. “You’re not going to want market risk.”
Through the first six months of this year, active managers topped indexes in five of 14 categories including municipal bonds and short- and intermediate taxable bonds, according to data from S&P Dow Jones Indices. That is coming off a 2017 in which actively managed funds had their best year since 2012, when active managers beat passive funds in nine of 13 categories the firm then measured.
Pacific Investment Management Co.’s Total Return exchange-traded fund—a smaller, more liquid version of one of the largest actively managed bond mutual funds in the world—has posted a negative return of roughly 1.7% this year, counting price changes and interest payments. The Bloomberg Barclays aggregate index of U.S. bonds has returned minus 2%.
Should yields continue to rise, advocates of active portfolio management say investors would be better served by a human being shielding them from the parts of the bond market most likely to suffer losses versus an index which includes all bonds, without regard to their potential risks.
“This is going to be a test for active managers at how skillful they are at positioning for a higher interest-rate environment,” said Aye Soe, managing director of global research and design at S&P Dow Jones Indices.
It is a situation many expect to persist, with the Treasury Department expected to run trillion-dollar deficits for the foreseeable future. As issuance increases, funds that use the Bloomberg Barclays aggregate index as a guidepost for portfolio composition will wind up owning increasingly large amounts of Treasury debt. Independent bond analyst David Ader predicts Treasurys will make up half of the U.S. bond market and the indexes that track it by 2028.
Still, because many individuals invest in bond funds to protect against losses in their stock portfolios, there are advantages to indexes that reflect the constituency of bond market borrowers instead of optimizing returns, said Josh Barrickman, who manages Vanguard Group’s bond index fund. While corporate bonds, for example, offer higher yields than Treasurys, U.S. government debt tends to post high returns during periods when investors shun risk, he said.
The changing composition of bond market indexes can exert a powerful force over what resides within their bond mutual funds without their becoming aware of it, according to fund managers and analysts. Treasury Department data shows that the category of investors that represents mutual funds bought about one half of the $2 trillion of U.S. government notes and bonds sold at auction last year. That is up from about one-fifth of the $2.2 trillion sold in 2010.
Should slowing growth lead business conditions to worsen, corporations have the option of borrowing less. Not so the U.S. government. Because legally mandated spending on unemployment insurance and other safety net programs tends to rise when growth slows, wider budget deficits and more Treasury debt could ensue. That means many bond investors could face conditions where there is no alternative to holding a rising share of government debt.
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