What Is Happening Now That QE II Is Over?
The Treasury is still issuing bonds--it disinvests civil service retirement trust funds when it does so, but it is still issuing bonds. Who is holding them at today's very healthy prices? Who is buying them at today's very healthy prices?
David Greenlaw's guesses:
Morgan Stanley - Global Economic Forum: Who Will Be the Marginal Buyer of Treasuries Post-QE2? June 02, 2 Analysis of the impact of QE1 conducted by Fed staffers concluded that yields (or term premiums) on longer-maturity securities were reduced by around 50bp. The market adjustment process at the conclusion of QE1 was relatively smooth. However, the bulk of the Fed's purchases in QE1 involved mortgage-backed securities, and MBS supply was unusually depressed as the buying wound down. Given that Treasury issuance is expected to continue at an extremely elevated clip for the foreseeable future, how will the market adjust to the loss of most Fed buying? In other words, who will be the marginal buyer of Treasuries going forward? Our analysis suggests that heavy buying by the largest foreign holders of Treasuries will be needed to avoid a back-up in yields....
In 2010, net issuance by the Treasury Department amounted to about $1.6 trillion. Roughly half of these securities were purchased by foreign investors (more on this later). Other big buyers included households, pension funds and the Fed.... The household sector... is a residual that includes all sectors for which the Fed does not have hard data - for example, domestically based hedge funds, endowments and foundations - as well as any data errors.... Indeed, we suspect that a significant portion of the spike in household purchases of Treasuries seen in the flow of funds accounts during 2009-10 reflects a data error....
There have long been questions surrounding the estimates for the foreign sector. The Fed relies on the Treasury International Capital System (TICS) data. But TICS-based estimates often differ substantially from estimates of flows into the US compiled by other nations, such as Japan. Also, the Treasury Department conducts benchmark surveys of foreign holdings (as opposed to purchases) of US assets at different points in time, and these figures often imply a much different flow of purchases during the relevant interval than seen in the TICS figures. Indeed, we suspect that a significant portion of the elevation in the household sector holdings of Treasuries seen in recent years actually reflects foreign investor activity that was not picked up by the TICS.... Quite simply, Treasuries are not a favored asset class of the typical household investor....
Looking at other investor categories, a few developments are worth highlighting. First, commercial banks are not typically big buyers of Treasuries.... The pension category has also shown a significant pick-up in the pace of Treasury buying in recent years. However, much of this upswing in demand seems to mirror a similar decline in holdings of MBS and thus appears to be part of an asset reallocation within fixed income....
With the Fed pretty much out of the picture after June, it seems clear that foreign demand for Treasuries holds the key going forward. While market perception is that foreign central banks and sovereign wealth funds play a dominant role in the Treasury market, the TICS data show much heavier buying of Treasuries by private foreign investors in recent years. During the past year or so, the biggest foreign buyers of Treasuries have been domiciled in the UK, Japan and Canada (in that order)....
At the end of the day, continued heavy buying by the largest foreign holders of Treasuries will probably be necessary to prevent a back-up in yields post QE2.... Finally, we would note that even if foreign investors step up and absorb all of the securities that the Fed has been buying, they won't provide details on the amount and timing of their purchases several weeks in advance - as the Fed currently does. So, at the very least, we should see greater market volatility once the Fed moves to the sidelines.
Haven't seen either the backup or the volatility--so far. It seems as though the foreigners are stepping up...
