Would Someone Please Buy US Treasury Bonds? (#GotBitcoin?)
The erosion of demand in emerging Asian markets reflects their maturation into more stable economies. Would Someone Please Buy US Treasury Bonds? (#GotBitcoin?)
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.
Treasury Exploring New Debt Products, Including 20-Year Bond
Agency looks for new ways to attract investment as analysts see years of growth ahead in federal budget deficits.
The Treasury Department said Wednesday it was considering several possible new debt products as officials seek to find more ways to attract investment as budget analysts expect years of continued growth in federal budget deficits.
The agency is considering adding new bonds with maturities of 20- and 50-years as well as a new floating-rate note linked to the proposed replacement for the troubled London interbank offered rate.
The task of raising money to pay for government operations is taking on added urgency because analysts expect the U.S. to run years of trillion-dollar deficits, even as the economy is in the midst of its longest expansion on record. The government spent nearly $1 trillion more in fiscal 2019 than it took in—the highest deficit in seven years.
Years of rising budget deficits have put the Treasury on track to sell the largest amount of longer-term bonds and notes on record. Government bond analysts said that the agency needed to find new ways to attract investment now, before a potential slowdown in the future overtaxes its ability to efficiently fund operations when rising safety-net spending could lead to greater borrowing needs.
“It seems they’re getting to the upper limits of what they can raise with the current suite of products,” said Gennadiy Goldberg, a government bond analyst at TD Securities. They need both new short- and long-term securities because “deficits are only expected to increase,” he said.
Government deficits have now increased for four years in a row, the longest stretch of U.S. deficit growth since the early 1980s, a period marked by two recessions and a jobless rate near 11%. The budget gap widened 26% in the fiscal year that ended Sept. 30, to $984 billion from $779 billion deficit the previous year, the Treasury said, as rising government outlays continued to outpace tax collection.
Treasury Secretary Steven Mnuchin said last month the Treasury was “very seriously considering” issuing a 50-year Treasury bond next year, as the administration looks to take greater advantage of low interest rates to slow soaring borrowing costs.
Should the Treasury add a 50-year security, it would be following other governments, including the U.K., Austria and Italy, which have broadened their efforts to attract capital by selling so-called ultralong bonds. Offering a 20-year bond would be a reintroduction of a security last issued in March 1986.
“In the long-run, they urgently need new securities,” said Thomas Simons, a money-market economist at Jefferies Financial Group.
A Treasury advisory committee said it expected to see “meaningful demand” from markets for a new 20-year bond, particularly from corporate pensions and insurance companies, but less so from foreign investors. The panel said the addition of a 20-year bond “could be a positive addition to Treasury’s issuance tool-kit,” but said more discussion was needed on the expected pricing, size and sustainability of demand before making a final decision.
That group, the Treasury Borrowing Advisory Committee, or TBAC, which is composed of large financial institutions, has tended to be skeptical that selling 50-year bonds would produce lower borrowing costs for the government over time.
Those doubts are outweighed by the risk the Treasury faces from having to continually roll-over a rising quantity of short-term debt, Mr. Simons said.
The government should look to add new securities, particularly if it can broaden its investor base, at a time when the economy is still strong and before a slowdown makes the need to raise money quickly more pressing, Mr. Simons said.
“If they’re under duress and they need them, that’s a significant problem” that could make it more difficult to raise money quickly, he said.
The Treasury also said it was closely monitoring the Fed’s recently announced purchases of Treasury bills following strains in money markets last month.
“The Fed purchases are still in the early stages and at this point we’re monitoring how the purchases program will evolve and any effects on the market,” a Treasury official said Wednesday. “It would be premature to draw any conclusions at this point.”
The Fed began buying short-term Treasury debt earlier this month and said it would continue the purchases—starting at $60 billion a month—into the second quarter of 2020. That marked a turnaround for the central bank, which until August had been shrinking its nearly $4 trillion balance sheet.
The funding pressures related to shortages of funds that resulted from an increase in federal borrowing and the central bank’s decision to shrink the size of its asset portfolio.
The TBAC, warned the purchases could lead to scarcity in the T-bill market if the Treasury doesn’t change its coupon auction sizes, but it recommended keeping issuance unchanged in the current quarter.
The TBAC also said the Fed’s efforts to boost reserves—deposits banks keep at the Fed—should help control money market rates in the near term, but could prove insufficient to prevent year-end funding stress similar to that seen during the fourth quarter in recent years.
The committee expects little or no change in borrowing through the current fiscal year, but said Treasury could need to increase coupon auction sizes in fiscal 2021.
Northern Trust Testing Fractionlized Bonds on Blockchain
Custody bank Northern Trust is testing the trading of fractionalized bonds on a blockchain.
Working with Singapore-based debt markets company BondEvalue, the bank is providing asset servicing for large, high-grade bonds that will be tokenized and divided for retail investors on Hyperledger Sawtooth. These bonds are normally too large for individual investors, but the quality of the bonds is attractive.
The move shows Northern Trust’s continued interest in the technology after it developed then sold its private equities blockchain, which shortens the time to market for new high-tech private equity funds. With $124.3 billion in assets, Northern Trust is the 24th largest bank in the U.S.
“We’re building capabilities we feel will be reusable across multiple asset classes and multiple jurisdictions,” Justin Chapman, global head of market advocacy and innovation research at Northern Trust, said of the new bond pilot. “Our focus on this initiative is to help bring the exchange to life and then we offer the highest grade asset servicing capability in that digital environment.”
Through the Monetary Authority of Singapore’s Sandbox Express, BondEvalue was given permission to launch a blockchain-based bond exchange in Singapore. Northern Trust will custody tokenized bonds and conduct transactions with the regulator’s oversight.
If the pilot is successful, the bank plans to also participate in the development of BondEvalue’s business model.