If foreign investors en masse are gorging on U.S. Treasuries, central banks may be beginning to lose their appetite.
Official U.S. flows data show that overseas private sector investors - banks, asset managers, insurance funds, pension funds, retail investors - are loading up on Treasuries while the official sector’s holdings are flat-lining at best.
As long as this active or de facto retreat from central banks is more of a whimper than a bang, the $26 trillion U.S. government bond market should be relatively unaffected. One group of buyers is simply replacing another.
But it may come with a price - a rising ‘term premium.’ That’s the amorphous amount of compensation investors demand for buying long-dated bonds instead of rolling over bills. It is the premium for unquantifiable risks in the future beyond current assumptions on the long-term path of inflation or policy rates.
Price-sensitive buyers with more of an eye on generating returns may not always be as reliable as price-insensitive buyers perhaps more concerned with capital preservation, liquidity and cautious reserve management goals.
Foreign central banks and the U.S. Federal Reserve were the two price-insensitive buyers and holders of Treasuries for many years, and their huge demand helped explain why term premium went negative even as U.S. borrowing rocketed.
But both are now backing away - the Fed is reducing its balance sheet and foreign central banks are no longer buying in as large size. Indeed, there are signs they are actively selling.
The latest U.S. Treasury International Capital (TIC) data show that overseas investors held a near-record $6.68 trillion of U.S. Treasury notes and bonds in November, but within that, central banks’ stash was near its smallest since 2011.
When adjusted for valuation effects - namely the ebb and flow of bond prices and the dollar’s exchange rate - official sector holdings fell by $49 billion in November. That was the biggest decline since September, 2022 and the fourth reduction in five months.
Total foreign holdings, meanwhile, rose by almost $60 billion on a valuation-adjusted basis, indicating that overseas private sector investors hoovered up $110 billion. In the first 11 months of last year, total foreign holdings fell only once.
Fed and Treasury data for the first 11 months of last year show that on a valuation-adjusted basis, overseas investors’ Treasury notes and bonds holdings rose by $428.4 billion. Of that, central banks accounted for only $31.9 billion.
Yields of between 4.5% and 5% for the world’s most liquid - and yes, safest - security, depending on the maturity, are attractive, so it is perhaps little surprise that the private sector’s interest has been piqued.
Torsten Slok, chief economist and partner at Apollo Global Management, notes that foreign private sector holdings now outstrip foreign official sector holdings for the first time in about a quarter of a century.
“With the Fed raising rates and the dollar going up, yield-insensitive central banks have been selling Treasuries to limit the weakening of their domestic currencies, and yield-sensitive foreign private investors have been buying Treasuries to benefit from higher yields and a rising dollar,” Slok noted last month.
That may change this year if the Fed cuts rates, yields fall and the dollar weakens. But if the same dynamics play out in the euro zone, Britain and elsewhere in the G10 currency world, perhaps not.
Right now, foreign central banks’ holdings are down to around $3.4 trillion, and their collective footprint in the overall U.S. Treasuries market has rarely been smaller. Their share of outstanding bonds is just 14%, down from 25% before the pandemic and a record 40% in 2008.
There’s little to suggest this trend is about to change any time soon.
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