What’s Behind the Weakness in Treasury Bonds?

A Smorgasbord of Sellers

Reuters reported on Friday that foreigners have sold some $66 billion in treasury debt in June, with the official sectors of China and Japan the main culprits:

“China and Japan led an exodus from U.S. Treasuries in June after the first signals the U.S. central bank was preparing to wind back its stimulus, with data showing they accounted for almost all of a record $40.8 billion of net foreign selling of Treasuries.

The sales were part of $66.9 billion of net sales by foreigners of long-term U.S. securities in June, a fifth straight month of outflows and the largest since August 2007, U.S. Treasury Department data showed on Thursday.

China, the largest foreign creditor, reduced its Treasury holdings to $1.2758 trillion, and Japan trimmed its holdings for a third straight month to $1.0834 trillion. Combined, they accounted for about $40 billion in net Treasury outflows.

Comments from Federal Reserve Chairman Ben Bernanke on May 22 that the central bank could reduce its four-year asset buying or quantitative easing (QE) program by September fueled a sell-off in U.S. Treasuries.

"China's net selling of U.S. treasury could be a reaction to the possible QE exit," said a senior economist at the Chinese Academy of Social Sciences (CASS), a top government think-tank. Speaking on condition of anonymity, he said China's currency reserves management had become much more pro-active.

"Holding too much U.S. debt is not wise at a time when Treasury yields rise and prices fall. On the other hand, the adjustment has been marginal considering China's massive holdings of U.S. debt, and China cannot dump U.S. debt, which could spook markets and upset the U.S. government," he said.

But Bank of Thailand Deputy Governor Pongpen Ruengvirayudh said the decision to reduce Treasury holdings was not a new one taken in light of the Fed's tapering expectations. "We have adjusted (our strategy on the U.S. Treasury in the foreign reserves) for a while," she told reporters.


"The sell-off in Treasuries and Bernanke's tapering remarks are related," said Michael Woolfolk, global market strategist at BNY Mellon in New York. "Lightning doesn't strike in the same place twice, but Bernanke repeated his comments in June and that roiled the market."

(emphasis added)

This article's conclusion is almost certainly wrong. The numbers are certainly correct, but the assumption that the selling has anything to do with the Fed planning to slow down its inflationary policy is absurd.

First of all, the amount of foreign selling is really quite small compared to the size of the market, although it is undoubtedly the case that what used to be a tailwind has become a headwind. So why are the treasury debt holdings of Asian nations declining? The main reason are their declining trade and current account surpluses, which appear to be reversing the previous need for dollar recycling. This is also reflected in a declining US trade deficit. Although a smaller trade deficit has a positive effect on GDP, in terms of the US economy it is mainly an indication that consumer spending is weakening. That in turn is happening because real incomes are stagnating/declining, while credit growth ex student debt is weakening as well. In other words, consumers have yet to readopt their bubble habits of yore. That may not happen for a while.

Listen to: Simon Mikhailovich: Bonds Are Not A Safe Haven - Today's Population Hasn't Experienced a Bond Debacle

As to 'tapering' of 'QE', it should be remembered that treasury bond yields rose during both 'QE1' and 'QE2'. They didn't rise 'in spite' of the Fed's buying, but because of it. When the central bank engages in inflationary policy, inflation expectations tend to increase, and inflation expectations are a far more powerful driver of bond prices than any single buyer will ever be.

However, things have changed with the adoption of 'QE to infinity'. Let us first look at another big seller

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