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Central banks are still buying large quantities of Treasuries

by Brad Setser
March 7, 2009

There has been a lot of chatter recently about the risk that foreign central banks would lose their appetite for Treasuries just as the US stepped up its issuance. The Fed’s custodial data, though, isn’t sending any warning signals. The CFR’s Paul Swartz calculated the 13 week (think 3 month) increase in central banks’ custodial holdings at the New York Fed.

Central bank purchases are down a bit from their December high (at their peak, central banks added more than $200b to their Treasury portfolio during a 13 week period) but remain very, very strong. $150 billion over 13 weeks (3 months) is a big number. Central bank purchases in the first quarter of 2009, for example, look to exceed central bank purchases in the first quarter of 2004. And that was when Japan was investing what then was considered a huge sum in the Treasury market.

Strong demand for Treasuries now is in some sense a surprise — as central banks aren’t adding to their reserves at the same pace they once did and thus have less to invest. Central banks were almost certainly net sellers of reserves in the fourth quarter. And in the first quarter the only major potential source of reserve growth is China. The oil exporters are selling their reserves to offset the impact of low oil prices (and to finance domestic bailouts; think of the UAE’s bailout of Dubai).

The rise in Treasury holdings in the last 13 weeks isn’t simply a function of Agency sales either. Agency sales of $50b offset only a third of the $150b rise in Treasuries; the net increase in central bank custodial holdings was still close to $100 billion.

The 52 week change in the Fed’s custodial holdings of Treasuries is still running at around $500 billion — and the total increase, net of Agency sales, is around $450 billion. The US current account deficit over this period will only be a bit larger.

Unless reserve growth resumes — and it may well, as it is quite likely that a host of emerging markets will conclude from this crisis that they need more not fewer reserves — it is hard to see how that pace can be sustained. Unless, of course, central banks shift in mass out of Agencies and into Treasuries.

p.s. The growth in the Fed’s custodial holdings of Agencies from 2005 to mid 2008 reflects, above all, the growth in the Agency portfolios of China and Russia. We more or less know this from the survey data. Japan and Korea also contributed as both were reallocation a fraction of their reserve portfolio from Treasuries to Agencies during this period. But the big buyer of short-term Agencies during this period was Russia and the big buyer of long-term Agencies (including Agency MBS) then was China.

29 Comments

  • Posted by hujintaoismydawg

    that’s not what the 13wk chart shows. from the time agencies and treas parted to the highest spread, agencies were down 200b and treas up only 180b or so.
    a little panic at cfr?

  • Posted by K T Cat

    “Strong demand for Treasuries now is in some sense a surprise — as central banks aren’t adding to their reserves at the same pace they once did and thus have less to invest. Central banks were almost certainly net sellers of reserves in the fourth quarter. And in the first quarter the only major potential source of reserve growth is China.”

    Sounds like a one-shot deal.

    I really appreciate the analysis, Brad. It helps me connect the dots that I see from trading and reading Across the Curve. I couldn’t figure out why Treasuries weren’t crashing yet.

  • Posted by jonathan

    I assume you mean you’re surprised – somewhat- by the size of the purchasing. As the scope of the new world disorder grows clearer the various trading metrics indicate loss of faith not only in recovery but in the ability to get back cash. I assume governments feel that too, but perhaps they have an added incentive, in the knowledge that our Treasuries are the last haven.

  • Posted by OjO

    Treasuries (or the dollar) will crash. It may take a few weeks or months, but there will be a crash. The U.S. budget and other deficits are generating holes in terms of voluminous Treasury issuances that are simply too huge to fill (as in, mathematically impossible). The U.S. economy will simply have to shut down its deficits and start exporting to repay its debts. Subsidies from China and other emerging countries in the form of bulk Treasury purchases are nice, U.S. consumption-wise, but they have had a terrible impact on the U.S. manufacturing/ real economy export sector and have led to huge wastes of resources through investments into non-productive, consumption-related assets (i.e., U.S. mortgages). This state of affairs is not sustainable in the long run; look at the U.S. financial sector, the U.S. household sector – the next domino to fall from debt overhang will be the U.S. government, which has been all too willing to absorb the financial sector’s endless liabilities. The country is not generating enough production to pay back its ballooning debts. If this had happened to any country other than the U.S., there would have been a run on the local currency a long, long time ago.

  • Posted by Anon

    A silent $1 trillion “Run on Britain” by foreign investors was revealed yesterday … The Bank of England said that there had been a large fall in deposits from the United States, Switzerland, offshore centres such as Jersey and the Cayman Islands, and from Russia.

    http://www.independent.co.uk/news/business/news/run-on-uk-sees-foreign-investors-pull-1-trillion-out-of-the-city-1639413.html

  • Posted by MakeMeTreasurySecretary

    A bid off-topic for this article but relevant to an important theme: The dollar.

    Brad, I wish you could commend on Ambrose’s article:

    http://www.telegraph.co.uk/finance/financetopics/recession/4939796/Europes-banks-face-a-2-trillion-dollar-shortage.html

    What on earth is Ambrose Evans-Pritchard talking about?

  • Posted by Cedric Regula

    Brad:

    Dose the custodial data for treasuries give what the maturity mix is, ie t-bills thru 30 year bond?

  • Posted by Cedric Regula

    MakeMeTreasurySecretary:What on earth is Ambrose Evans-Pritchard talking about?

    Ditto. I know we have eurodollars in europe, but I’m very curious to know what they meant in the article when they say the banks are “borrowing short in local currency and lending long in dollars”. And they end up with a 2 trillion shortfall of dollars???? And who are they lending to??? Is it some real customer or is this some interbank trading scheme again?

    The only thing that I can figure that means is it’s some sort of eurodollar fractional banking-money multiplier thing. What kind of craziness is that?

    I know they were making franc and euro loans to eastern europe, which were popular due to a low interest rate that the banks offered with the more stable currencies. Kind of like teaser loans here.

    The Fed already sent them a few hundred billion in currency swaps. Now they may need a trillion or two as well???? Does anyone in finance know simple arithmetic???????

  • Posted by Cedric Regula

    Anon: “Run on Britain”

    These flows happened last year, so we already know the impact. The pound went from 2 to 1.40, and the BOE monetized the shortfall plus some. Britain government debt just jumped from 46% of GDP to 146% of GDP.

  • Posted by bsetser

    Evans-Pritchard is drawing on an important article by the BIS that i will comment on soon.

  • Posted by bsetser

    some of the withdrawal of funds from the UK was probably a withdrawal of offshore $ deposits from UK banks; it wasn’t simply a pound negative flow. this shows up in the US data as a fall in US lending to the rest of the world, as US institutions stopped buying s-term securities/ stopped placing deposits with UK based institutions.

  • Posted by purple

    Where else are people going to put their money ..to paraphrase Lueo Ping “we hate you guys…but what are we going to do ?”

    It’s more likely that other countries, needing cash, are going to be squeezed out by the explosion of U.S. debt.

  • Posted by Dennis Redmond

    OjO wrote:

    This state of affairs is not sustainable in the long run; look at the U.S. financial sector, the U.S. household sector – the next domino to fall from debt overhang will be the U.S. government

    I’m not so sure about this. The problem isn’t really the household sector or government — the Federal Reserve’s flow of funds data says total household debt went from 62% of GDP in 1990 to 97% in 2008 (Quarter 3, the most recent data available). Corporate debt went from 65% to 79% of GDP. Government debt (Fed plus state): 60% to 73%. These are manageable levels.

    The problem is Wall Street went on a once-in-a-century debt binge. Financial firm debt went from 45% of GDP in 1980 to 211% of GDP in 2008. As long as the Banks of Russia and China keep buying Treasuries, and both countries have pragmatic leaderships who have signaled they will do exactly that, the US government should be able to monetize some of that private sector debt and buy the world some time to come up with a smarter, fairer and hopefully more ecological global economy.

  • Posted by chaingangcharlie

    More or less OT China report on the BBC’s entertaining Robert Peston blog :

    http://www.bbc.co.uk/blogs/thereporters/robertpeston/2009/03/china_still_buying_the_world.html

  • Posted by chaingangcharlie

    “Brad, I wish you could commend on Ambrose’s article:

    http://www.telegraph.co.uk/finance/financetopics/recession/4939796/Europes-banks-face-a-2-trillion-dollar-shortage.html

    What on earth is Ambrose Evans-Pritchard talking about?”

    Ambrose Evans-Pritchard announces the imminent end of the world on a regular schedule, about 5 times a week. But I suppose one of these days there really will be a wolf & he can say ‘told you so’.

  • Posted by jimspassion

    This state of affairs is not sustainable in the long run; look at the U.S. financial sector, the U.S. household sector – the next domino to fall from debt overhang will be the U.S. government
    I’m not so sure about this. The problem isn’t really the household sector or government — the Federal Reserve’s flow of funds data says total household debt went from 62% of GDP in 1990 to 97% in 2008 (Quarter 3, the most recent data available). Corporate debt went from 65% to 79% of GDP. Government debt (Fed plus state): 60% to 73%. These are manageable levels. The problem is Wall Street went on a once-in-a-century debt binge. Financial firm debt went from 45% of GDP in 1980 to 211% of GDP in 2008.
    If the World economy is reliant on household consumption and spending as the basis of any activity, then where do you think the 211% of GDP came from ?(indirectly or directly)

  • Posted by Twofish

    Remond: The problem is Wall Street went on a once-in-a-century debt binge. Financial firm debt went from 45% of GDP in 1980 to 211% of GDP in 2008.

    I’m not sure that number means very much. If you put money into a bank, you are increasing “financial firm debt.” The thing about financial firm debt is that they are balanced by assets, and so the important number is the difference between debt and assets.

  • Posted by Twofish

    Financial firms are in this mirror world. In general it’s healthy for an economy to have financial firms with massive amounts of debt. A checking account is debt from a bank to you, if people have massive amounts of savings, this is generally a good thing. As long as the bank is putting that money into useful assets (i.e. loans to be repaid) things are good.

  • Posted by Kafka

    Mr. Setser nice work. I am under the impression that most of the increase relates to short term treasuries not long term. What is the Treasury gonna do when it can no longer Kite its treasury payables at short term lower rates, remember the U.S. is gonna need about $2 Trillion this year and what rational actor would purchase longer term treasuries at these rates? I predict the Fed will have to buy and use them to repot the banks bad collateral. Don’t fool yourself, the increase in financial debt is a major problem especially when the assets are worth much less than the liabilities, a mathematical result that must occur when fractional reserve lending is used to create false wealth and asset values, fool me once shame on me fool me twice shame on, uh I forget how it goes.

  • Posted by Bubblicious

    The current T-bill bubble is about as bad as gets for the world. And when it breaks, it’s going to have a domino effect. The U.S. really shouldn’t be going into such a large debt hole. They think they can continue to issue infinite amounts of Tbills but what’s going to happen one day when the auction falls short?

    If the flows would at least go into equities maybe the downturn wouldn’t be so severe…

    just a thought.

  • Posted by Confused

    @ chaingangcharlie

    any one care to make a prediction?

    -According to chief economists at the UN, they predict the U.S. dollar is in for a hard landing in the 2nd half of 2009.

    Then

    -Accoring to the piece by Ambrose-Pritchards it appears the author (and perhaps) BIS argue the dollar will strengthen.

    Thoughts?

  • Posted by chaingangcharlie

    # Confused says:
    “-According to chief economists at the UN, they predict the U.S. dollar is in for a hard landing in the 2nd half of 2009.
    Then
    -Accoring to the piece by Ambrose-Pritchards it appears the author (and perhaps) BIS argue the dollar will strengthen.
    Thoughts?”

    Aside from opining that AEP is always a bit on the hysterical side, i reckon my thoughts on this have no value whatever. He might even be right to be hysterical, I don’t know.
    I will say that I am reading a little book by a guy called Graham Turner called (imaginatively) “The Credit Crunch” which makes the point that ‘off-shoring’, while undeniably reducing labour costs, also effectively killed the US / UK consumer, leading to a situation where corporations can get stuff made for next to nothing but now find there is no-one left in the West with any spare money to actually BUY it. The housing boom allowed us all to *imagine* we did for a while, that’s all.
    Moral of story : Don’t forget your employee is also your consumer. Better keep him wealthy.

  • Posted by confused

    i’m also leaning toward the position of the respected economists at the UN…

    Pritchards although in line at times, has been greatly off on his commentary. thanks for your input charlie.

  • Posted by DOR

    If China’s trade surplus in the first two months fell 60+ percent, and some Mainland economists are predicting a Q-2 trade deficit, what is the likely impact on T-bills and the dollar?

  • Posted by Rajesh

    I predict continued strength in the dollar and continued stupidity at the U.N. (after all that’s what its there for.)

  • Posted by bsetser

    given china’s jan surplus and the y/y fall in commodities, tis rather unlikely the jan-feb surplus (y/y) fell 60%. it may be down v q4, but that is the normal seasonal pattern. i would be equally surprised if china swings into a q2 deficit. that would imply that the us deficit turns into a surplus — or that there is an enormous swing in China’s balance with europe. lots of things are possible but a q2 deficit in china seems unlikely to me.

  • Posted by K T Cat

    Bubblicious,

    “The U.S. really shouldn’t be going into such a large debt hole. They think they can continue to issue infinite amounts of Tbills but what’s going to happen one day when the auction falls short?”

    I would argue that the current administration doesn’t care. Jobs and the economy are less important than CO2 and global warming, health care for all, wealth redistribution, and so on. The evidence is all there in the speeches and is certainly supported by their actions.

  • Posted by John

    My prediction: Whenever a single T-bill auction fails to generate a healthy coverage ratio, there will be a panic in the T-bill market. That, or a spike in the price of oil (or any other indicia of inflationary pressures) will trigger a downward spiral.

    The Central Banks know that they will get paid for their bonds with depreciated dollars. That is why there has been such a strong move towards short-term maturity T-bills. The 30-yr. bond is not a smart investment.

  • Posted by don

    ‘lots of things are possible but a q2 deficit in china seems unlikely to me.”
    While possible, it would signal a true disaster for China’s economy.

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