Nobody Wants The Bonds!

Nobody wants the bonds! That’s sarcasm.

It’s fair to say the oversupply panic that typified daily Treasury market commentary from late-July through mid-October has abated. The bond market zeitgeist shifted this month when Janet Yellen tacitly bowed to the term premium in the refunding announcement and the incoming macro data suggested the US economy is finally beginning to cool.

Still (and notwithstanding any false optic created by the ICBC hack), another lackluster 30-year sale underscored lingering sponsorship concerns around the long-end of the Treasury curve and the fact remains that the buyer base is transitioning away from price-agnostic investors towards market participants who want to be compensated for the “risk” (note the scare quotes) of locking up their money for an extended period of time.

That’s the backdrop for the first foreign “buyers’ strike” in Treasurys in 28 months. Here, “buyers’ strike” means net selling by foreign investors. The figure below gives you a sense of things.

September was obviously a harrowing month for Treasurys, and as it turns out, foreign investors sold more than they bought that month. It was the first net outflow since May of 2021.

I should be clear: Interpreting the TIC data is more art than science, and even if you master that art, about the best you can do is offer a partial explanation for yesterday’s price action — the report comes on a two-month lag.

Still, it’s worth a mention. Foreign demand wasn’t especially robust during Q3, and that might’ve contributed to the demonstrable back-up in long-end US yields.

The figure below shows China’s hoard. The value of those holdings fell in September by the most in a year (-$27 billion). It was the sixth straight decline.

Do note: That’s a nuance-free assessment. It’s just the Mainland China line item from the TIC report. To say there’s more to it than that when it comes to tabulating Chinese holdings of US debt securities would be to materially understate the case.

Brad Setser offered an incisive take that folds in pretty much every key dynamic mentioned above. There’s really no utility in trying to one-up Setser in this department. He spends a lot of time with this data. Below, find his quick summary, as published in the public domain on Friday.

There is no doubt that foreign demand isn’t driving the market as in the past. It isn’t that foreign demand has gone away (apart from the month of September), but the rise in the stock of Treasurys not held by the Fed is increasingly being absorbed domestically. In a big global sense, this shouldn’t be a surprise — foreign central banks (directly and indirectly, via their holdings in third party custodians) have long been the main driver of foreign demand for Treasurys and reserve growth has stalled.

China’s holdings (which are mostly from its reserve manager, SAFE) are about half as big relative to US GDP as at their peak and are now small versus the broader market. With the inverted curve, hedging costs are now prohibitive for primarily hedged investors — such as Japanese commercial banks, Japan Post Bank and (to a lesser degree) the insurers.

So, foreign demand hasn’t disappeared — some investors still like the absolute yield pick up that Treasurys offer versus most relatively safe foreign bond markets. But it hasn’t matched total supply. One way Treasury has adapted, it seems, is by increasing bill issuance relative to notes — as foreign investors historically have preferred notes, while domestic investors (MMFs in particular) like bills.

All this matters, at least in theory, because an increase in net Treasury issuance (due to a bigger fiscal deficit or QT) relative to stable institutional sources of demand (foreign reserves) should impact the term premium. Though just as I started to think this could start to be a factor, Treasury limited its note issuance (versus expectations) and the Treasury market rallied on the back of falling inflation in the US: Issuance versus price-insensitive demand is only one factor that determines yield.


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