Foreign investors bought about 21 percent of the $218 billion of two-year notes auctioned this year, down from 31 percent in 2004, according to Treasury data. They also purchased about 21 percent of the $154 billion of five-year notes sold by the Treasury, compared with 30 percent last year.
The figures don't include the results of last week's sales, which will be released in December. Indirect bidders, a larger group that includes U.S. institutional investors, foreign central banks and overseas investors, bought 34.9 percent of the debt sold. The percentage is down from 47.4 percent at the quarterly auction of three-, five-and 10-year notes a year earlier.
Foreign investors increased Treasury holdings by 9 percent this year, compared with more than 23 percent in each of the past two years. The current pace is the lowest since 2001, when net purchases rose 2.45 percent.
``Foreign buying is a very important source of demand for Treasuries and the market is concerned by evidence that it is waning,'' Joseph Di Censo, a bond strategist at Lehman Brothers Inc. in New York, said Nov. 11. ``This would obviously put upward pressure on yields. The Treasury will always be able to finance the budget deficit. The real question is at what cost.''
Every time the Treasury has an auction of US debt, the bond market holds its collective breath to see what the indirect bidders' participation is. (Indirect bidders are foreign central banks.) If the number is low, traders grow concerned. To demonstrate the importance of foreign participation in the debt markets, last week a high foreign participation rate for the 10-year auction was cited as the reason for Thursday's stock market rally - which is the first time I have ever seen that reason cited for a market rally. (In contrast to a strong participation rate for the 10-year issue, the 2 and 5 year issue were extremely low).
Foreign purchases of US Treasury debt are important for two reasons. First, the US needs foreign capital to finance the trade deficit. The total monthly trade deficit number indicates how much foreign capital the US must import that month. For example, last month's trade deficit was 62 billion dollars, indicating the US must import a similar amount or more of foreign capital to finance the trade deficit. Secondly, US Treasury purchases are a de facto measure of confidence in the US dollar as a reserve currency.
Over the last several years, China, Japan and South Korea have all stated they will start to diversify their currency reserves away from dollars. According to TIC data, Asian central banks are not meaningfully increasing their US Treasury holdings. Japan had 679 billion of Treasuries in January and 684 in August. Over the same time, China increased its holdings from 223 to 248 billion. Korea's holdings increased from 53 to 59 billion. (The biggest increase occurred with British purchases, which increased 75%, from 101 to 174 billion).
The final reason foreign purchases are so important is their affect on US interest rates. A study by the Federal Reserve concluded:
Foreign flows have an economically large and statistically significant impact on long-term interest rates. Controlling for various macroeconomic factors we estimate that had there been no foreign flows into U.S. bonds over the past year, the 10-year Treasury yield would currently be 150 basis points higher; even a step-down to average inflows would imply an increase of 105 basis points. The impact of the headline-making foreign official flows - a relatively small subset of total foreign accumulation of U.S. bonds - is also significant but markedly smaller. Our results are robust to a number of alternative specifications.
Yesterday, the 10-year Treasury closed at a 4.60% yield. 105 basis points above this is 5.65% and 150 basis points over 4.60% is 6.10%. These increases in yields would have a significant impact on the US housing market, the engine of the current US economy.
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