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Us bonds face gloomier future as selling continues { September 7 2003 } Original Source Link: (May no longer be active)
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US bonds face gloomier future as selling continues to increase
By Jenny Wiggins
Published: September 7 2003 18:56 | Last Updated: September 7 2003 18:56
The US bond markets have had a rough few months, with an intense bout of heavy selling that started in mid-June knocking government debt prices sharply lower.
But the markets are already considering the prospect of an even gloomier future.
Many market participants say more selling is on the cards, this time led by foreign investors.
Over the past decade, foreign investors have been gathering up increasing amounts of US debt securities.
Foreigners now own one-third of the US Treasury market, up from one-fifth eight years ago, according to Merrill Lynch.
In recent years, Asia has become the most noticeable buyer of Treasury debt. Japan is the largest holder of Treasury securities, owning some $442bn at the end of June, followed by the UK with $123bn and mainland China with $122bn.
Lehman Brothers says the Asian region now accounts for some 39 per cent of international purchases of US bonds, nearing the 43 per cent owned by Europe.
In an environment where bond prices are falling and the US government's financing needs are increasing - the Treasury will issue a record amount of debt this quarter to help fund its large budget deficit - these large foreign holdings are starting to raise some concerns.
Economists say that the US relies on foreign purchases to help finance its current account deficit, which runs at some 5 per cent of GDP.
For some time, a happy equilibrium has existed between the US and Asia. The US buys Asian exports, and Asian countries use income from the sale of their exports to buy US assets to help prevent their currencies from rising against the dollar.
However, investment managers have begun to realise that this equilibrium is unlikely to last forever, particularly if bond yields remain low and the US continues to put pressure on Asian countries to revalue their currencies.
Last week, Bill Gross, the chief investment officer at bond fund Pimco, the largest bond fund in the US, expressed fears that China could start a bond market rout.
"Since [China's] monthly trade surplus of $10bn plus with the US implies a $120bn annual addition to its dollar reserves, there will come a time when their hundreds of billions, if not half a trillion or so, in holdings of US notes and bonds look a tad too risky," he told investors in his September investment outlook.
"In turn, the hundreds of billions that the Japanese and other Asian countries have been buying in order to keep their currencies competitive with the Chinese yuan (renminbi) and the US dollar will be subject to a sanity check as well."
Fixed-income strategists do not expect Asian central banks to start selling immediately.
But they are considering the pressure any foreign selling could put on the bond markets if it comes amid a big increase in debt supply.
"It could weigh on an already heavy market," said Amy Falls, head of global fixed-income strategy at Morgan Stanley.
The government may also be hard-pressed to find replacement buyers for its debt if Asian investors do sell.
"It's very important to maintain central bank demand," said Ethan Harris, chief economist at Lehman Brothers.
"There's nothing close to that kind of demand from private borrowers."
There are already signs that overseas investors have become less enamoured of US debt.
Foreign investors have been selling the so-called "agency" debt issued by mortgage financiers Freddie Mac and Fannie Mae following an accounting scandal at Freddie Mac.
There is currently some $186.6bn in agency debt securities held in custody for foreign accounts at the Federal Reserve, down from $189.8bn on June 4, before the scandal broke.
This debt is a popular alternative to Treasury securities because investors believe agency securities hold an implicit guarantee from the US government due to Freddie and Fannie's special status as "government-sponsored enterprises".
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