Brad Setser

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Dwindling foreign demand for Treasuries …

by Brad Setser
July 24, 2006

Floyd Norris of the New York Times highlights something that was also on my radar screen:  a sharp fall off in foreign demand for US treasury bonds. For the first time in years, the US budget deficit is being financed by domestic investors.

Foreign inflows to the US haven’t fallen off, to be sure.   But the composition of these inflows has changed.  Foreigners are buying more agencies and US corporate debt and fewer Treasuries.  First quarter data is here; the TIC data from April and May do not indicate that the story has changed. 


Well, one theory is that foreign central banks have stopped financing the US.   I don’t believe that.  I do believe that the set of central banks now adding to their reserves is far different than the set of central banks adding to their reserves in 2003 and 2004.  Oil exporters have replaced Japan and (to a lesser extent) many Asian countries other than China.    And as I almost constantly note, the oil exporters generally don’t show up in the US capital inflows data directly.   Their presence is felt, but not directly observed.

In 2005, there was a sharp fall in (recorded) central bank demand for Treasuries, a fall off the coincided with the end of Japanese central bank purchases in the fall of 2004 (it took Japan a while to place the huge sums of dollars bought in late 03/ early 04 in the bond market).   However, there was no fall-off in overall foreign demand for Treasuries.   Some of that demand came from the Caribbean – think hedge funds.  But lots came from London – think oil state central banks and investment funds. 

In 2006, both central banks and private (or not so private) investors abroad stopped buying Treasures.   What happened?     Here is my guess:

  • Caribbean holder of Treasuries sold in the first quarter.  Net sales were around $8.5b.  See the Treasury bulletin.  Hedge funds unwinding curve flattening trades?   
  • Some oil exporters reduced their Treasury purchases.   Russia isn’t the culprit: it never bought treasuries, only agencies for some reason – but it has reduced its agency purchases this year.     But the others must have shifted their portfolios around a bit – either buying more agencies and corporate debt, or just parking their cash in bank deposits.  Don't look in the offiical data to confirm this — OPEC holdings of Treasuries are up.  But the total observed flows here are so small relative to the oil surplus that it is likely that most of these flows show up in the data from London.  Looking only at what shows up in the US data as "OPEC" holdings can be misleading.
  • Some central banks may have opted to hold short-term t-bills rather than longer-term bonds.   Though the TIC data doesn’t support this story in the aggregate – there hasn’t been a surge in overall central bank holdings of Treasury bills.
  • Norway sold.
  • Japan seems to be shifting its reserve holdings slowly out of the Treasury market and into the Agency market.  At least that is my interpretation of the data from the New York Fed’s custodial accounts.  Look at the 52 week changes in Agency and Treasury holdings.  This story is supported by the q1 data in the Treasury bulletin: Japanese investors sold $19b of Treasuries and bought $11b of agencies.  That data aggregates the activity of the central bank and private investors, but it is suggestive. 

Sum it all up, and all these changes seem to have had an impact – net flows into the Treasury market from abroad this year have been negligible.    If you take out the Caribbean, some of this effect goes away.   China clearly has been a net buyer ($15b in q1).    But there still have been something of a shift.

Read Norris.   And look at his graphs in the Saturday New York Times if you have a chance.  I was planning to do something similar, but he beat me to the punch in a big way.  Though there are a couple of fun twists that could be added to the Norris graphs.


  • Posted by Dave Chiang

    Hi Brad,

    US Treasury Bonds are absolutely a terrible deal for any long term investor, including foreign central banks, for a number of sound economic reasons. First, reported official US consumer price inflation ran at 4.3% in the last 12 months, so a Federal Funds rate of 5¼% is less than 1% in real terms even before you take account of hedonic pricing (ie. statistical creative accounting by the Federal Reserve). While borrowers have to pay somewhat higher interest rates today, monetary policy remains extremely loose. I still get over a dozen credit card offers in the mail every week offering 0% interest for 6 months. Second, much of the current inflationary pressure results from international higher energy prices with Chinese oil import demand increasing 15% year on year. These inflationary price pressures are unlikely to ease with global energy reserves inadequate.

    Bloomberg News mentions that ,”The conventional wisdom that bombs and geopolitical risks are boosting oil prices and shaking up stock and bond markets is only half right. The other catalyst is one that won’t soon go away: Asia’s economic boom. A slow-motion Energy demand shock is evolving from Asia. After all, Asia is home to about 3 billion people edging toward simultaneous booms in industry, urbanization and demand for automobiles and air travel. That will become a bigger problem when 400 million Chinese and 400 million Indians — or more — own cars”.

    Noted investor Jim Rogers is now predicting $100 per barrel oil in the not too distant future. Lots of luck.


  • Posted by Dave Chiang

    Financial Bubbles caused by cheap cash menace world economy

    ” Call it the weapon of financial destruction. There is so much cheap financing sloshing around the global economy, despite simultaneous interest rate tightening at the world’s three major central banks, that some analysts warn that financial bubbles are bound to keep building.

    “Monetary authorities have lost control of money,” said Brian Reading, director at Lombard Street Research, a London macroeconomic forecasting company in a research note.

    Claudio Borio, head of research at the Bank for International Settlements, estimates that global liquidity conditions remain very generous.

    Borio calculates in a recent research paper that the official policy rate charged by the G3 central banks, adjusted for consumer inflation, is about two percentage points lower than the average real G3 policy rate over the last 15 years.

    Gabriel Stein at Lombard Street estimates that lending outside the banking sector for major economies, those producing roughly $100 billion or more in annual GDP, grew at its fastest rate in a decade, or by 10 percent year on year in March.

    He calls this growth rate destabilizing and blames central banks for starting to tighten rates too late. “Money and credit growth are still too rapid. We are not talking yet about any serious tightening of monetary policy,” he said.

    Thomas Mayer, European economist at Deutsche Bank, also finds monetary conditions quite loose, despite simultaneous credit tightening by G3 central banks.

    “The deeper question is whether central banks truly have the will to stay the course that they appear to be on,” he said.

    Lombard Street Research has dubbed this cycle — where cheap central bank money fires up excess credit growth, which in turn fires an asset bubble — a weapon of financial destruction.

    “Every time you inflate a bubble with cheap money, you trash someone’s balance sheet,” said Stein.

    “First corporate balance sheets, now the households and next the public sector. Where do you go to inflate the next bubble? And they bigger they get, the more difficult it is to get back into financial shape.”

    – Reuters News Agency

  • Posted by groucho

    dave, excellent post. You may want to check out Edward Chancellor’s “Crunch Time For Credit?”

  • Posted by MrBill

    RE hedge funds, the caribbean & domestic buyers of US treasuries

    Just some back of the envelope calculations here. The 10Y-UST was trading at 99.00 in JUne for a yield of 5.25% it is now 100.96 in July yielding 5.00%.

    The BOJ seems to not want to raise rates too far too quickly. For those entrepid who are willing to take a little currency risk, you can still borrow 3-mos. yen at 0.04% (+/-). At 116.65 spot the implied one-year forward is 111.00 using a money market rate of 0.65%. If your view is that 110.00 is a pretty strong floor for the strength of the yen, and that in any case the BOJ will be a modest rate hiker, plus (as per the previous comment above) there will still be plenty of global/yen liquidity sloshing about to keep markets funded, then you can play various spread flattening/widening games with the UST yield curve that looks like a ‘U’ at the moment.

    And using leverage from repoing your USTs you can definitely enhance the spread between borrowing at 0.40% and investing at say 5.25%/5.00%. But of course your risk is that the yen appreciates through 111.00, so you might use a dynamic currency hedge or speculate that the yen’s upside from 110.00 is limited? (i.e. delta hedge using spot FX or buying yen calls funded by selling yen puts).

    If some feel that after August’s rate hike that the Fed will pause, but that also the BOJ will not aggressively raise rates either, then there is still a interest rate differential to exploit, and with a directional view on the yield curve, the USD/JPY exchange rate and using leverage via the repo market there will still be hedge funds & others willing to buy UST as they are liquid and easy to repo.

    Not a game I would play, but…

  • Posted by Guest

    Rather than quoting huge chunks of an article, would it not be better if posters simply quoted a few pertinent lines together with a link?

    “Noted investor Jim Rogers is now predicting $100 per barrel oil in the not too distant future.”

    That was pointed out by the ever-vigilant Dr. Roubini a long time ago.

  • Posted by Guest

    Dave Chiang,

    Your highly selective quotes do little to enhance your credibility. Thus, for example, from the Reuters article you cherry picked this:

    ‘”Monetary authorities have lost control of money,” said Brian Reading, director at Lombard Street Research, a London macroeconomic forecasting company in a research note.’

    In context, it reads like this:

    ‘”Monetary authorities have lost control of money,” said Brian Reading, director at Lombard Street Research, a London macroeconomic forecasting company in a research note.

    His statement is provocative, and few economists are willing to go quite that far.

    But there is widespread concern that global liquidity conditions — measures of real policy rates versus how much money and credit circulate worldwide to finance growth — remain very loose despite a bout of central bank tightening.’

  • Posted by Guest

    “…hedge fund managers and banks’ proprietary traders still need to make a lot of money out of small moves in prices. So, no, the carry trade is not over… But the “funding currency” for these trades is likely to change, or at least not be so concentrated in the yen… The Japanese Ministry of Finance and the Bank of Japan share the same analysis of the Japan’s economy but they have different priorities. When there is a conflict, you can bet on the ministry winning. The Ministry of Finance is most concerned about rises in rates because some day it will face the horror story turned reality of refinancing the world’s biggest debt burden… Now, consider the Swiss franc…”

  • Posted by Guest

    other guest – if you read the full article at all, may I suggest that you simply add, or highlight, the chunk of text that (you think) may balance the lead (at least that’s my approach) and ignore the person who submitted it? I’d really hate to see this blog degenerate into a critique of one participant’s posts.

  • Posted by Guest

    A stretch for this post, but thinking about changes in strategies and tactics which may affect/be affected by markets, this one involves:

    “…lending directly to hedge funds or to their investors or managers… typically to solve a problem known as “Pentagon Finance”… “Although we structure the finance as a loan – either through a loan note or by way of a fund derivative – the money goes into the fund as equity [that is, AUM]. “The hedge fund managers give up none of the equity and/or income stream in the business. They just pay us an interest rate on the loan amount. Better still, we can structure the loan as a month to month facility. Hence, if they want to repay, they can do so at any time. “The question hedge fund managers have to ask themselves in this case is: ‘What is cheaper for me, debt or equity?’ If they think their business is valuable, then clearly the debt is cheaper and more flexible. If they think equity is cheaper, that tells you a lot about their business prospects, and tells prospective investors a lot, too!…”

  • Posted by MrBill

    India Oil Demand Rises Substantially

    “INDIA OIL DATA: June Crude Oil Imports +26.5% On Year

    NEW DELHI -(Dow Jones)- India’s crude oil imports jumped 26.5% on year in June to 9.60 million metric tons, a senior government official said Monday.
    He said the higher imports were mainly due to greater volumes of oil purchased in the spot market.
    In June 2005, India imported 7.59 million tons of crude.
    The country also imported 1.19 million tons of petroleum products in June, higher than the 969,000 tons imported during the corresponding period last year, the official said.
    India imports around 76% of the crude oil it processes. The country’s annual domestic consumption of oil products is close to 112 million tons at present.”

    Sorry they did not give any year to date figures, so I do not know if June is above trend or not? Thanks.

  • Posted by Guest

    Mr. Bill – You may have been reacting to this morning’s FT piece?

    “India’s central bank on Tuesday raised borrowing costs by 25 basis points, describing it as a “modest pre-emptive action” against economic overheating driven by “disturbing signs” of pressures crimping domestic demand…”

    We’ve spent quite a bit of time talking about China and Chinese statistics, with little attention to India.

  • Posted by Guest

    I feel like I’m swatting at shadows here Brad, because as you know, I have a lot of problems with the data.

    But thinking about Norway / Scandinavia, the Caribbean, have to wonder if we should be paying more attention to the ways any number of smaller and gateway/hub nations – and as pointed out, in many cases city regions – are re-positioning and leveraging themselves in this evolving global system?

  • Posted by Guest

    “At a time when oil prices are above $70 a barrel, the Mideast is exploding and more than two dozen central banks have raised interest rates since May, derivatives are allowing companies to borrow a record $607 billion and obtain relatively cheap financing… By bundling more than 10 percent of that into so-called collateralized debt obligations, bankers are able to provide more cash to companies, especially those that need it the most. Defaults fell to the lowest since 1997 as sales of CDOs rose 63 percent to $177 billion in the first half, according to the Bond Market Association, a New York-based trade group of dealers and underwriters… Derivatives “help explain why the default rate has remained this low as long as it has,” said David Hamilton, director of default research at New York-based Moody’s Investors Service, the bond rating company founded in 1900. We are “seeing a historic shift…”

  • Posted by Guest

    What The Dollar Bears Have Been Waiting For: China should increasingly diversify its foreign-exchange reserves to reduce the risk of losses from declines in the dollar, the country’s National Bureau of Statistics said… “The U.S. dollar may continue to weaken, increasing the risks of foreign-exchange losses in our currency reserves,” the statement said. Speculation that the dollar will fall “also boosts expectations that the yuan will strengthen.”

  • Posted by MrBill

    Yes, saw that India piece in the this morning, although at 6% rates are still below growth and therefore stimulative, however, that is leaving aside the situation in India (China too) of a two speed economy where those higher fuel prices and interest rates are affecting the rural economy more than the high speed internet and offshore services growth economy.

    I saw a classic cartoon a few months ago, and wish I would have saved it. Two young Indian boys confront their aging father who appears to be a poor farmer. “Father, we’re off to join the information economy, may we take the cow?” Two speeds indeed! ; – )

  • Posted by Guest

    Lex: Chinese forex reserves

    This is the first time that China has been explicit about concerns over the value of its reserves. Diversification, however, is a complicated issue…

    A large part of China’s reserves is, in effect, an investment asset. Diversification to protect that asset’s value, however, may be self-defeating. Given their size, sales of dollar reserves would weaken the currency and reduce the value of China’s remaining holdings. Dollar sales, moreover, would increase expectations for renminbi appreciation and further encourage short-term capital inflows at a time when China already faces rapid money supply growth. Any diversification is, therefore, likely to be gradual and confined to new accumulation of reserves.

    Arguably, it has made sense for China to hold a large proportion of reserves in dollar-denominated financial assets. Lacking a sophisticated domestic capital market, China has benefited from recycling part of this capital through foreign direct investment, which has supported growth.

    There are two longer-term problems, however. First, there is no reason why European capital markets cannot perform an increasing part of this function. Second, China has encountered political resistance to its efforts to diversify from US financial assets into real ones. If constraints are placed on what the Chinese can buy, they will simply look elsewhere.

  • Posted by Guest

    re: “…If constraints are placed on what the Chinese can buy, they will simply look elsewhere.”

    I’ve got problems with this, because in a world in which strategic resources and critical global infrastructure are expensive, other places to look are increasingly limited. It’s my impression that enough willpower backed up by money and political clout, will always conquer barriers and bring about desired results, although dressed up in ways that are politically correct and not obvious to the casual observer.

    The Lex statement also ignores the fact that all nations – and assets worth buying, will present any number of constraints to various classes of prospective buyers.

  • Posted by Guest

    “…Derek Halpenny, senior currency economist at Bank of Tokyo-Mitsubishi UFJ, said he placed no significance on the story, given the fact that the statistics bureau played no role in foreign exchange policy in China. “The focus on the story is more a reflection of there being a lack of issues to focus on for foreign exchange market participants,” said Mr Halpenny. “What is noticeable though this relatively quiet period is that the dollar has stabilised against the euro and the yen despite the declining probability of a quarter point US interest rate rise at the upcoming FOMC meeting on August 8.” Mr Halpenny said the relatively modest decline of the dollar since Federal Reserve chairman Ben Bernanke signalled that long-term inflation risks were fairly contained in… a pause by the Federal Reserve may not undermine the dollar as much as widely expected,”…”

  • Posted by psh

    [ D = f(willpower, clout, conquer, results) s.t. any number of constraints ∈ words words words ]


    Oh I see. Our geostrategic rivals will have to knuckle under to us in order to secure their strategic reserve of frappucino resources and critical Myrtle Beach condo timeshare infrastructure.

  • Posted by OldVet

    Re: India’s petroleum bill, the import/refining companies are squeezed because the govt subsidizes fuel costs in a very big way, around 10% of Govt revenues going to subsidies. Water is subsidized also, which is quite expensive and encourages misallocation of both fuel and water to very antiquated agricultural activities.

    Re: China’s use of reserves. No reason at this point to continue recycling reserves thru FDI, when domestic non-export businesses could use so much local development cash. Some credit lending to small businesses would enable transition of agricultural labor to more value added production/services, and not necessarily in the large existing urban areas. Spread the wealth so to speak, across the territory, more evenly. No?

  • Posted by Guest

    Wondering if it might be at all helpful, if remotely possible to breakout crossborder flows and holdings of: 1) consortiums; 2) state-owned and public-private partnerships – given that at least some state-owned firms seem to engage in cross border transactions? (what are the defining differences between state owned entities and PPPs?); 3) assets controlled by HNWI’s (surely more than condos); 4) cross border intrafirm transactions (and if this may need to be broken out into different sectors given the very different ways each are structured)…

    The dominant influences controlling the allocation of much of the world’s capital seem to be much more difficult to define.

  • Posted by bsetser

    China also subsidizes fuel and water by controlling prices, and the state owned refiners are therefore squeezed. sounds similar.

    like old vet’s point re helping domestic non-export businesses …

  • Posted by Guest

    re: “Our geostrategic rivals”

    might be your point – given your absolute confidence in the finer points of distinguishing ‘American investment’ from ‘foreign (in your mind evil?) investment’.

  • Posted by Guest

    ‘The Chinese have a reputation of being adverse to credit, but all they really lack are suitable financial products like educational loans and home mortgages’

    Stephen Green – “In the old days, when communist central planning suffocated China’s economy, fixed-asset investment was the regime’s measure of economic progress. The more tonnes of steel produced, slabs of concrete poured, and gallons of crude oil pumped out of the ground, the better. The consumption-based economy, to which the capitalist West had apparently succumbed, was written off as a paper tiger…”

  • Posted by psh

    I ♥ our geostrategic rivals. They are the grownups. Hugs & kisses for them & their beautyful investment.

  • Posted by Anonymous

    Hi Guest,

    Short, to the point, and whatever most mainstream economists may presently state.

    During a presentation to business writers in 2001, Larry Lindsey noted that the interacting combination of: de facto low to zero reserve requirements in the U.S., the globalization of finance, the rise of non-bank banks, the credit money creating power of Government Sponsored Enterprises,,,has created “nuclear credit fission”; shorthand for “monetary authorities have lost control of money”, itself merely a restating of what Walter Wriston had said years before. Would note as well that Doug Noland has more than sufficiently documented the reality of this over the last years.

  • Posted by Guest


    If, for example, SAMA purchased from the U.S. Treasury outside of normal auctions, would this be completely invisible?
    I ask only because this is part of what David E. Spiro in his 1999 book “The Hidden Hand of American Hegemony…” determined had taken place during part of the 1970s.

  • Posted by bsetser

    re: SAMA purchases outside the normal auction, it depends.

    If SAMA acting in its own name bought a bond from Citi NY, it should register in the data as a sale from a US resident (citi) to an official institution in Saudi Arabia (SAMA).

    If SAMA asks a private custodian in london to buy a treasury bond on its behalf, it would show up as the sale of a US treasury by a US resident to a private institution (the custodian) in london.

    If SAMA bought a Treasury bond directly from the Bank of Japan, the Bank of Russia or a German pension fund, whether directly or through an intermediary, the US would never know (at least not until the survey was conducted … ). there is no requirement that the sale by one non-resdient of US bonds already held outside the US to another non-resident be reported.

    at least that is how i understand it.

  • Posted by Guest


    please remember that the economy is a dynamic system. Your continued focus on statics leaves little chance that you will correcly understand cause and effect. Your failure as well as Dr. Roubini’s failure to accurately predict rests on your desire to see a particular outcome.

    The US economy continues to grow despite your repeated insistance that we are all doomed. Your simple and incorrect focus on the CA deficit must end. You need to look at the entire economy and its prospects.