When the Federal Reserve announced it was ending its program of quantitative easing in 2014, bond guru Bill Gross, asked the question “who is going to buy Treasuries now?” Before the official announcement of the taper, there was widespread anxiety that interest rates would take off should the Fed vacate the bond market. The “temper tantrum“ of 2014 was very short –lived and bond yields started a steady descent well into 2016.  

Every year since 2009, the major Wall St. firms forecasted a steady increase in long term yields, citing, among other factors, that bonds would be out. The Fed’s easy money policy would restore inflation at the expense of the bond holders. Often we hear  pronouncements that the Great Rotation is about to take place in which investors dump bonds in favour of equities and other risky assets. Again, the question asked is “who is going to buy Treasuries now?”

Wall St firms totally missed the huge demand for Treasuries in 2012-16, as central banks, sovereign wealth funds and large international private funds dominated the purchases of new federal debt. Domestic primary dealers drew smaller portions of new debt as overseas entities absorbed the new supply. The United States did not have to raise interest rates to attract overseas investors, because European rates headed into negative territory. Finally the build up in current account surpluses in Asian countries meant that foreign reserves had to be recycled back into U.S assets.

Now this question arises once again, as investors pile into the stock market in anticipation of strong economic growth and  higher inflation. The Trump Administration is talking about major tax reforms and huge infrastructure spending that will reflate the U.S. economy. Bond investors are suppose to run for the hills in such an environment.

So to get a handle on the question of “who will buy Treasuries now?”, we need first to turn to the question of who owns the federal debt today. Table 1 sets out the major holders of U.S. federal debt. By far and way, the largest owners are foreign governments. Next in line is the Federal Reserve which is expected to maintain that position indefinitely. State and local governments will continue to be important customers for new bonds. The commercial banks holdings are required to hold Treasuries to support their capital ratios. However, the private pension funds and insurance companies are greatly under represented, despite their need to hold long term assets to satisfy growing future liabilities.

Table 1

This past year saw a significant shift among the major owners. China unloaded over $3 trillion in bonds in an effort to ease the downward pressure the Chinese currency. As for Japan, some point to U.S. political uncertainties as the reasons behind Japan’s selling. Others argue that the prospects for greater U.S. federal deficits and ensuing inflation account for the selling. Although it is easy to assume that China and Japan are”dumping” Treasuries, both countries appear to have adjusted their portfolios to changes in currencies and international interest rates.

But the big story is the re-entrance of U.S. domestic buyers who bought an above-average amount of U.S. debt compared to previous 52-week periods going back to pre-2008 crisis (see Chart 1).

Chart 1

In particular, pension funds have been very active in the Treasury market, since they realize that they are under-funded in fixed income. The pension funds are rebalancing their portfolios in favour of the more traditional investment strategy. The recent surge in longer term interest rates, starting last November offers an excellent opportunity for a pension fund to de-risk their portfolio by picking up long term debt with higher yields. There is healthy appetite for longer duration bonds, despite the stock market’s view that we can expect higher inflation.

Once again, the question of “who will buy Treasuries now” offers up several willing customers.