Across the globe, governments have issued trillions of dollars in bonds to cushion the pandemic-related economic blows and survive the COVID-19 public health crisis. Today, these debt instruments have flooded financial markets. But not all bonds are created equal, with Treasury securities the go-to investment for Wall Street, insurance juggernauts, and foreign investors. Or, at least, this had always been the case. But while the rest of the world drools over the next U.S. debt issuance, China does not share this enthusiasm.
Gimme Some Lovin’
In August, foreign holdings of U.S. government debt climbed to an all-time high of $7.56 trillion, with strong demand from Japan and the United Kingdom leading the charge. The world appeared to love all of America’s asset classes, with considerable gains in long-term bonds ($30.7 billion), corporate stocks ($8.7 billion), and corporate bonds $14.7 billion.
But while foreign central banks appeared to trim their Treasury International Capital (TIC) inflows to the U.S. for the fourth consecutive month, private entities overseas acquired an astounding $51.6 billion, the second-largest acquisition since August 2018. And this appears to be the theme since the beginning of the coronavirus pandemic: Foreigners are propping up U.S. Treasury securities.
However, the main story in the monthly snapshot of major foreign holders of Treasurys was China. It turned out that Beijing sold $21 billion in United States debt, reducing its total holdings to $1.047 trillion, the lowest level since August 2010. Because of geopolitical strife, it had long been considered that the world’s second-largest economy would unwind its holdings of U.S. bonds.
Foreign Friends or Enemies?
The opinion is split as to whether foreign investors are bullish or bearish on U.S. Treasurys.
A recent report by the Institute of International Finance (IIF) surmised that America was one of the few nations to endure an outflow of foreign investment in government bonds in 2020. It turned out that more global traders were interested in what Germany and Japan were selling at the height of the coronavirus pandemic. The September report noted:
“For a few scary days in early March 2020—at the height of the first COVID wave—U.S. Treasuries stopped trading like a safe haven asset, with 10-year yield shooting up as the S&P 500 was tumbling. In subsequent weeks, it took $1.5 trillion in emergency quantitative easing (QE) by the Fed to stabilize the market, in what has now been written off as a market ‘plumbing’ episode.”
Study authors made two conclusions. The first is that there needs to be “a reassessment of the safe-haven character” of U.S. bonds. The second is that international investors are performing greater scrutiny of America’s deteriorating fiscal condition, with President Joe Biden and the Democrats proposing trillions of dollars in new spending and the national debt exceeding $28 trillion.
At the same time, a separate report from analysts at Société Générale suggested that foreign investors maintain a fierce appetite for U.S. debt, with overseas funds wanting more Treasurys. Put simply, as domestic investors search elsewhere for better yields, the study asserted that foreigners could be supporting U.S. government bonds over the next couple of years.
A Wild Ride in a Boring Market
The U.S. bond market has captured headlines as of late. From softer auctions of 20-year Treasurys to the roller coaster rides in the benchmark 10-year bond, this typically boring segment of the financial markets has been wildly entertaining. But it is the future that will prove to be popcorn-inducing fun. Will the world imbibe German and Japanese government bonds? Will the globe, especially China, begin to shun Treasurys? What role will the Federal Reserve’s tapering play in debt markets? Tune in next time when Washington publishes another edition of TIC data.
~ Read more from Andrew Moran.