By Jamie McGeever
ORLANDO, Fla. (Reuters) – Conventional wisdom holds that central banks tapering their bond purchases will push bond yields higher – but recent U.S. and UK sovereign debt sales show foreigners willing to fill any gap in demand.
The Federal Reserve and Bank of England will likely be the first of the central banks in the G4 economies – the United States, Britain, Japan and the euro zone – to gradually unwind their huge monetary stimulus, perhaps eventually selling bonds back into the market and putting upward pressure on their sovereign bond yields.
Burned by the U.S. central bank’s ‘taper tantrum’ in 2013, which triggered an unwanted spike in borrowing costs and market volatility, especially in emerging market economies, policymakers will be keen to ensure minimal market disruption this time around.
Foreign investors stepping up to the plate would help allay policymakers’ concerns. Recent U.S. and UK debt auctions suggest that their appetite for yield, safe assets, and currency and geographical diversification is strong.
“Non-resident bond buying is an underappreciated force,” said Chris Marsh, senior advisor to Exante Data and a former economist at the International Monetary Fund, noting that demand from this source could help shape the U.S. and UK yield curves, depending on market conditions. “They could end up buying a lot.”
They are already buying a lot, record amounts by some measures.
‘Indirect bidders’ – widely considered a proxy for foreign investors, often central banks and reserve managers – scooped up 77.3% of the $41 billion 10-year U.S. Treasury bonds sold at auction earlier this month, a new record.
And Bank of England figures through the month of June show that foreign investors’ purchases of UK gilts rose to 98.5 billion pounds on a rolling 12-month basis, also a record.
Treasury data this week showed that foreign holdings of U.S. Treasuries jumped $67 billion in June to their highest since February 2020. Major foreign holders held $7.2 trillion in Treasuries, the second most on record..
Of course, it remains to be seen if this demand will hold up when tapering begins, and if so, whether it is sufficient to cap any spike in yields. Global market conditions and capital flow dynamics will go a long way to determining that.
There are few examples of similar scenarios to draw on, but the Fed’s ‘Taper Tantrum’ of 2013 and subsequent taper are worth considering.
The 10-year yield was already rising when on May 22 then-Fed chief Ben Bernanke told Congress that the U.S. central bank could dial down the pace of bond-buying “in the next few meetings” if conditions warranted.
It jumped to 3% from 2% in barely four months and Treasury market volatility surged. Indeed, the rise in implied 3-month U.S. bond market volatility in May of 2013, as measured by the MERMOVE index, remains the biggest monthly rise since 2009.
Once the Fed’s taper actually started later that year, the 10-year yield resumed its multi-year downturn on the way to an all-time low at the time of 1.35% in mid-2016.
Notably, that dove-tailed with a prolonged rise in foreign purchases of U.S. Treasuries at auction.
Indirect bidders accounted for 28% of purchases at the 10-year auction in March 2013. That share rose steadily in the following years, culminating in a then-record 73.6% in June 2016.
More broadly, as Robin Brooks at the Institute of International Finance in Washington notes, “inflows slowed a bit but foreigners never sold.”
The U.S. 10-year yield remains closer to 1% than 2% and some of the biggest names on Wall Street, including JPMorgan and Goldman Sachs, have recently lowered their year-end forecasts.
But a 1.25% nominal yield is attractive to a foreign buyer. Britain’s 0.55% is still tempting for investors in Japan and the euro zone, where benchmark 10-year yields are 0% and -0.5%, respectively.
Even accounting for the currency hedging costs euro zone and Japanese investors incur when buying Treasuries and gilts, returns are relatively high.
The prospect of Fed and BoE tapering contrasts with the European Central Bank and Bank of Japan, whose buying of domestic sovereign bonds are on such a scale that private-sector investors are facing a shortage of ‘safe’ assets to hold.
In that light, Treasuries and gilts may look attractive to foreign investors for some time to come.
(By Jamie McGeever; Graphics by Jamie McGeever and Saqib Ahmed in New York; Editing by Paul Simao)
