The US Treasury International Capital report
for the month of November 2017 was released yesterday. It showed that
the two largest foreign holders of US Treasuries, China and Japan, were net
sellers. China sold about $12.6 bln and Japan sold about $9 bln of US
Treasuries. Foreign investors sold $6.4 bln of Treasuries, meaning that outside
of China and Japan, other foreign investors were net small buyers of
Treasuries.
The offshore centers, where some hedge funds
may be located for tax purposes, of Bermuda and Cayman Islands were net
unchanged on the month. We know from more recent Commitment of
Traders data that large speculators turned net short 10-year Treasury futures
in the middle of December for the first time in eight months. The large
speculators have been short two-year Treasury futures since last May.
Sometimes the monthly data print obscures the
larger picture. Consider that last year through November, the TIC data
shows foreign investors bought $390 bln of US Treasuries. The US runs a
current account deficit and therefore must import capital. In the first
nine months of 2017, the US current account deficit was about $338
bln.
China's reserves fell in 2015 and 2016 by
nearly $1 trillion, and over this period its Treasury holdings fell by almost
$200 bln. In 2017, with the help of capital controls and a change the yuan's
direction, China accumulated reserves. China's reserves rose by
nearly $130 bln in 2017, while through November, the US estimates that its
Treasury holdings increased by $118 bln.
If China wants to accumulate reserves, it will
have to buy US Treasuries, even if not every month. There simply is
no other market as liquid and deep as the US Treasury market. Of course,
it could shift its allocation toward the euro but it gets significantly lower
yields and less liquidity. In contrast, Japan is not
accumulating reserves like China. Valuation shifts account for the $47.3
bln increase in its reserves in 2017. Japan's Treasury holdings fell by
$6.7 bln in the first 11 months of 2017.
Some observers have been playing up the
increased cost to hedge Treasuries as a reason Japanese investors sold
Treasuries. The TIC data shows that Japanese investors were net
sellers of Treasuries from August through November to the tune of about $30
bln, which is a minuscule fraction of its holdings. Consider that of its
$1.261 trillion of reserves in November, the TIC data shows Japan (not just the
BOJ, but probably mostly the BOJ) held $1.084 trillion of US Treasuries
then.
On one hand, Japanese institutional investors
are thought to be attract by the high yields available in the US Treasury
market. On the other hand, the wider differentials at short-end make
hedging the currency risk more expensive. This may help explain why
Japanese institutional investors have preferred European bonds, according to
the recent MOF data. Japanese investors have preferred UK, Swedish, and
French bonds.
At the same time, there seems to be other
forces at work besides relative yield curve developments. According
to the TIC data, Japan's holdings of US Treasuries peaked in November 2014 near
$1.241 trillion. They have fallen by a little more than $157 bln over
the past three years. Japan's Treasury holdings are at four-year
lows.
There also appears to be a large seasonal
factor that few observers have recognized. Specifically, over the
past decade, Japan often accumulates Treasuries in the first part of the
calendar year. It has been biased in the past several years to be sellers
late in the year. From 2007 through 2016, Japanese investors sold Treasuries in
December in seven of the 10 years. Beginning in 2015 and running through
2017, Japanese investors consistently sold US Treasuries from August through
December without fail. In the middle of next month, the TIC data for
December 2017 will confirm our suspicions that Japanese investors sold
Treasuries last month.
Disclaimer
More Thoughts about Japan and US Treasuries
Reviewed by Marc Chandler
on
January 18, 2018
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