The US national debt recently passed the 30,000 billion dollar mark. Since March 2020, the US national debt has increased by 7,000 billion dollars. All those “Treasuries” are ultimately part of one’s portfolio. Certainly now that some major buyers have dropped out this year, it remains to be seen whether enough buyers will remain.
Rising interest rates make US government bonds less unattractive than they were at the start of the year, but the rise in inflation means that interest rates are still extremely negative. That is when many traditional bond buyers turn away and, in recent quarters, there has been a large rotation out of bonds into equities.
The rise in interest rates now provides some buffer in case of an extremely negative scenario in the equity market, but for the time being, the correction in bonds this year is of greater magnitude than that in the equity market. Long-dated bonds in particular are taking an unprecedented beating.
The effect of the Russian expropriation
A quarter of US government bonds are held by foreigners. A total of 7,600 billion dollars according to the Treasury Department’s International Capital (TIC) data. Of that, 4,000 billion is held by foreign central banks and governments. Some of those central banks and governments will be wondering what to do with those positions.
After all, the Americans used the dollar as a weapon in the fight against Russia and overnight the Russian central bank could no longer access its dollar reserves. The same could happen to other countries. Think of banks in the Middle East and Africa, but also the Chinese central bank wants to reduce its position in Treasuries.
This central bank alone holds more than 1,000 billion dollars in Treasuries, just less than the 1,230 billion dollars that Japan has on its books. These large positions are the result of high exports to the United States. China wants to be less dependent on the US and is much less focused on exports to the United States than before.
Buying oil in dollars
Japan will have to spend its dollars on the strongly increased oil and gas prices. The country does not produce fossil fuels itself and has to buy them in dollars on the world market. As a result, for the first time in a long time there will be a trade deficit this year. Both countries will rather reduce their positions in Treasuries than increase them. More and more dollars are tied up in oil. With 100 million barrels a day and the fact that there are many months between production and consumption, this is quite expensive.
After China and Japan come the United Kingdom, Ireland, Luxembourg, the Cayman Islands, Switzerland, Belgium, France, Taiwan, Brazil and Canada. Many European countries now effectively buy their energy in euros, Swiss francs or British pounds. An energy boycott imposed by Europe is imminent and where in the past those euros, francs and pounds circulated back to Europe because the Russians bought houses, boats and football clubs or simply thought the money was safely stored in a democratic constitutional state, this is no longer the case. Europe will soon have to buy energy in dollars and, in order to do so, will have to draw on its dollar reserves (read: Treasuries) or earn new dollars. Not exactly countries that are going to invest heavily in Treasuries.
Effect of saving pension funds
The US government holds USD 6,500 billion in Treasuries, including those held by pension funds for military and other government employees, but the interest of these parties in Treasuries has been declining for years. More and more pension funds are beginning to relax due to the increasing age of the participants. Pension funds are also growing at a much lower rate than US government debt. In 2008, 45 per cent of Treasuries were parked here, now the figure is 21.5 per cent.
That percentage will continue to fall in the coming years, again no big buyers of US Treasuries. Then, of course, there is that other big buyer in the United States: the Federal Reserve. The quantitative easing policy has increased its balance sheet by 9,000 billion dollars, of which 5,700 billion are Treasuries.
In the space of a year, that position has increased by no less than 818 billion dollars, but that too is about to change. Until recently, the Federal Reserve was still buying 120 billion a month; soon the same Fed will be selling 95 billion a month. Even for the Treasuries market, this is a major shift in the supply/demand balance. So again, no interest in Treasuries for the time being.
Then there are the US banks that hold 1,700 billion dollars in Treasuries. The US banks are well capitalised, also because hardly any companies are collapsing. That is going to change because rising interest rates will ensure that the many zombie companies do not survive.
The rest is in the hands of institutional investors and private individuals. They own about 30 percent of all Treasuries. Insurance companies, mutual funds and other pension funds. Many of these institutional parties pursued a pro-cyclical policy. When interest rates fell, more bonds were bought as a result of rising commitments. Those days are over.
Asking for trouble
Now that liabilities are falling due to rising interest rates, the reins can be loosened. There is less need to invest defensively. Less in bonds, more in other categories. So here too there is little interest in Treasuries, at least not at current interest rates.
So there are few buyers for US government bonds. Bear in mind that many institutional parties are not guided by the level of interest rates. They are in bonds on the basis of laws and regulations. However, fundamentally something has changed. Foreign parties have been forced to face the facts this year about the risks of holding dollar reserves, the US government (pension funds and the Fed itself) has turned from a big buyer to a big seller and rising interest rates are strangely reducing the need for Treasuries as an interest rate hedge.
In this respect, it is strange that Treasury yields have not yet risen further, mainly because the market believes that inflation will return to between 2 and 2.5% in the very short term. That seems to be asking for accidents. Treasury yields will therefore have to rise gradually to attract new investors.
Han Dieperink is chief investment strategist at Auréus Asset Management. Earlier in his career, he was chief investment officer at Rabobank and Schretlen & Co. His contributions on InvestmentOfficer.lu appear once a week.
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