Is Foreign Demand for Treasuries Fading?

Speculation that China could be looking to reduce or even halt its U.S. Treasury purchases going forward has flooded media outlets recently and spooked investors. Following the news Treasury yields were sent to more than 10-month highs likely on concerns that significant changes to China’s Treasury holdings could trigger a sell-off in both bond and equity markets.

A strong 10-year Treasury auction on Wednesday countered that narrative, however, and helped to stem the losses tied to the China news. In fact, the auction saw its strongest overall demand since June 2016. Further allaying investors’ concerns was the degree of participation of indirect bidders since the group, represented by financial institutions like foreign central banks and viewed as a proxy for foreign demand, accounted for 71.4% of the bond purchases, the highest level since August 2016.

*Takedown refers to amount purchased

While foreign demand for U.S. debt remains robust, we are monitoring the potential impact of increasing hedging costs, as well shifts in foreign central banks’ monetary policy. Why are these important? Both have the potential to hamper demand for Treasuries and push U.S. yields up. Foreign investors usually hedge their currency exposure when investing in Treasuries; and increases in hedging costs, as we’ve recently seen for Japanese investors, can limit demand despite dramatic yield advantages between the U.S. and foreign government bonds.

Global central bank activity is another important factor impacting demand for Treasuries because, if other central banks become more aggressive in normalizing their monetary policy (i.e., raising rates), yields abroad could rise, making the debt more attractive to investors who may otherwise have purchased U.S. debt. While we don’t anticipate these factors causing foreign demand to fall precipitously, we continue to monitor these and other gauges of demand.

 

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