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Who Is Left Buying Treasuries?
We have long been concerned with where the clearing price of Treasuries would trade, once the Fed pulls back from its $85bn a month Treasury and mortgage buying program. Given that $85bn a month covers all fresh supply, the importance of the markets biggest buyer must not be underestimated.
This morning Deutsche Bank highlighted a few statistics which would certainly have been on the Fed’s mind when the decision for tapering was discussed last week. Deutsche noted that in Q2, UST issuance was significantly lower than in the previous year at just $299bn (versus last year at $1186bn). However, this was partially offset by the fact that during the period households sold $190bn, deposit institutions sold $100bn, money market funds sold $19bn and broker dealers sold $135bn. Overseas buyers bought just $85bn, which was a huge drop. Where would the price have been had the Fed not been buying at its current annual rate of half a trillion?
In Q3 we had the additional concern of a number of emerging market central banks selling $ denominated assets to protect their own currencies; this would of course include Treasuries. So, had the Fed tapered (and EM markets continued to decline) the selling vs. buying imbalance had the potential to be a far bigger issue. This had to be on the Fed’s mind, despite no mention of this in the press conference, but then how could they mention “we are worried about where yields might go if we don’t support all the supply!”
Anyway, since the non-taper we have seen Treasury markets sustain a nice little rally and for a short term move, we see this as justified. However, in the medium term we think that yields will struggle to maintain their present levels and that an orderly move higher is possibly the best that the Fed could wish for.