Treasuries and the Dollar

At the end of Sept, the IMF COFER data showed euro and yen reserve holdings rose faster than dollar holdings, even though dollar holdings rose as well. We are reluctant to read a new trend into one quarter's report. In addition, the TIC data shows foreign investors continue to increase their Treasury holdings.

The US Treasury Dept has sold some $1.6 trillion of notes and bonds this year. Foreign investors have bought 44%. In the same period a year ago, foreign investors bought 27% of the $631 bln of notes and bonds sold. In terms of dollars, foreign investors put bought a little more than $700 bln of Treasuries this year after $170 bln in the same 2008 period.

There are two other sources of demand for US Treasuries. US banks are holding more Treasuries, though their lending to the government does not completely offset their pullback in lending elsewhere. According to Bloomberg, bank holdings of US Treasuries have increased by about a quarter since the start of 2008 to $1.42 trillion.

The steepness of the Treasury's yield curve is one of the ways in which bank balance sheets are thought to heal. They borrow from the government at the short-end of the curve and lend it back at the longer end.

Another group that is showing a keener appetite for bonds is retail. Morningstar, which tracks investment flows into funds, reports that US fixed income funds drew some $255 bln in the Jan through Sept period. This contrasts with Morningstar estimate of only $14.5 bln going into equity funds.

Note that some of this money moving into bond markets seems like extending the maturity of money markets. Reports suggest that money market funds have seen about a $500 bln draw down this year. Nevertheless, money market accounts still hold almost $3.45 trillion, which is nearly $1 trillion more than there was in such accounts prior to the onset of the crisis.

While it would seem that there is sufficient fuel in money markets to continue to lift financial markets, it seems unreasonable to expect a return to status quo ante. One of the lessons that various market segments have taken away from the crisis is that one needs ample liquidity. Central bank are rebuilding reserves, even though prior to the crisis may observers argued many central banks were accumulating too many reserves. US and European corporations have issued a record number of bonds and an estimated half the funds might not have a set objective other than boosting cash. US retail investors also seem to have re-discovered fixed income. We also note that some emerging market countries are issuing bonds as well, even though there might not be a compelling need. Low rates seems to be an irresistible attraction.