First, let’s take a look at Bloomberg’s China Can’t Buy Enough Bonds as Dollar No Deterrent:
International investors are increasing purchases of Treasuries on a bet U.S. inflation will remain subdued, even as the dollar falls to the lowest levels of the year and the budget deficit tops $1 trillion.
Investors outside the U.S. bought 43.1 percent of the $1.41 trillion of notes and bonds sold by the Treasury Department this year, compared with 27.1 percent of the $527 billion issued at this point in 2008, government figures show. The Merrill Lynch & Co. Treasury Master Index of U.S. securities returned 1.18 percent in the third quarter after the worst first half on record as demand from the investor group that includes central banks climbed to record levels at Treasury auctions.
The trade-weighted U.S. Dollar Index’s 15 percent decline from its high this year on March 4 has proved no obstacle in Treasury auctions, aiding President Barack Obama’s efforts to sell an unprecedented amount of debt. Fund managers say their money is safe in the U.S. with expectations for inflation as measured by indexed bonds below the five-year average.
If the dollar index has declined since March 4, should we really be comparing year over year? After all, looking at the Trade Weighted Dollar Index, the period up to the peak was looking pretty good for the dollar. In fact, we’re still not back to the low levels of most of 2008. So, instead of comparing year over year, let’s see if the analysis of quarter over quarter changes anything (obviously it does, or I wouldn’t have wasted my time typing this).
You might be surprised to find out that it’s not foreign purchases that are driving the treasury prices, but the Fed’s quantitative easing (printing money to buy treasuries). Zero Hedge comments in Federal Reserve Accounts For 50% Of Q2 Treasury Purchases (emphasis in original):
The degree of intermediation by the Federal Reserve in the issuance of US Treasuries hit a record in Q2, accounting for just under 50% of all net UST issuance absorption. This is a startling number, as the Fed’s $164 billion in Q2 Treasury purchases dwarfs the combined foreign/household UST purchases of $101 billion and $29 billion, respectively, over the same time period. In fact, the Fed was a greater factor in UST demand than all three traditional players combined: Foreigners, Households and Primary Dealers, which amounted to a $158 billion in net Q2 purchases.
This dramatic imbalance puts a lot of question marks over how the upcoming hundreds of billions in incremental Treasury purchases will be soaked up, now that QE only has $15 billion of capacity for USTs: with Households lapping up risky assets it is unlikely they will look at Treasuries absent some dramatic downward move in equities, while Foreign purchasers, which many speculate are in a game of Mutual Assured Destruction regarding UST purchases, have in fact been aggressively lowering their purchases of Treasuries (from $159 billion in Q1 to $101 billion in Q2, an almost 40% decline in appetite!). Will the US make these purchases much more attractive come October when QE for USTs ends? And if so, what kind of rates are we talking about? One thing is certain: in terms of priorities of the Federal Reserve, keeping the equity market buoyant, is a distant second to ensuring successful auction after auction well into 2010. After all there is near $9 trillion in budget deficits that need financing over the next 10 years.
Contrary to the Bloomberg article, over the period that the dollar has been declining, the Fed has been engaged in quantitative easing, and Foreigners have been buying less (at least they haven’t turned into net sellers). Unfortunately, you’ll note that neither analysis has a perfect overlap with the time under consideration (except the Fed purchasing data, because that’s updated daily with no lag). The Q2 data just came out on Thursday.
What does this mean? I’m not an expert on the treasury market, so I couldn’t really say. However, the Fed QE program is ending in October (they only have $15B left). I can tell you that having the dominant player of a market disappear when the rate of supply increases tends to cause market disruptions. I wish I knew how to play this. My guess is that the Fed will start another QE program when this one is finished. Suddenly stepping on the brakes after driving the market forward seems a bit … odd. Stranger things have happened, though. Also, my ability to predict Fed moves is about on par with a coin flip.
