China is selling tons of US debt. Americans could not care less

NEW YORK (BLOOMBERG) - For all the dire warnings over China's retreat from US government debt, there is one simple fact that is being overlooked: American demand is as robust as ever.

Not only are US mutual funds buying record amounts of Treasuries at auctions this year, US investors are also increasing their share of the US$12.9 trillion market for the first time since 2012, data compiled by Bloomberg show.

The buying has been crucial in keeping a lid on America's financing costs as China - the largest foreign creditor with about US$1.4 trillion of US government debt - pares its stake for the first time since at least 2001.

Yields on benchmark Treasuries have surprised almost everyone by falling this year, dipping below 2 per cent last week. The 10-year note yielded 2.04 per cent at 12:12 pm in Tokyo Monday.

It's not the scenario that doomsayers predicted would leave the US vulnerable to China's whims. But the fact that Americans are pouring into Treasuries may point to a deeper concern: the world's largest economy, plagued by lacklustre wage growth and almost no inflation, just isn't strong enough for the Federal Reserve to raise interest rates.

"As you develop a more pessimistic view on global growth, inflation, and rates, asset managers are going to buy Treasuries in that environment," said Brandon Swensen, the co-head of US fixed-income at RBC Global Asset Management, which oversees US$35 billion.

Overseas creditors have played a key role in financing America's debt as the nation borrowed heavily to pull the economy out of recession. Since 2008, foreigners have more than doubled their Treasury investments and now own about US$6.1 trillion.

China has led the way, funneling hundreds of billions into Treasuries as the Asian nation boomed and it bought dollars to limit the gains in its currency.

Now that's changing.  China's economy grew 6.9 per cent in the third quarter, the slowest pace since the first three months of 2009, a government report showed Monday (Oct 19), even as it kept Premier Li Keqiang's target of 7 per cent growth in 2015 within reach.

This year alone, China's holdings have fallen about US$200 billion as it raises money in support of its flagging economy and stock market. If the pattern holds, it would be the first time that China has pulled back from Treasuries on an annual basis. The tally includes Belgium, which analysts say is home to Chinese custodial accounts.

The Chinese pullback has led some to raise troubling questions about the US's ability to borrow and refinance its obligations at ultra-low rates year after year. It's also reignited long-held concerns, aired over the years by both Republican and Democratic politicians, that China's ownership of US debt is a threat to America's independence.

Homegrown demand for Treasuries suggests there's no reason to panic.

American funds have purchased 42 per cent of the US$1.6 trillion of notes and bonds sold at auctions this year, the highest since the Treasury department began breaking out the data five years ago. As recently as 2011, they bought as little as 18 per cent.

As a group, US investors of all types have also stepped up their holdings of Treasuries since they fell to a low in mid-2014. In 2015, that share has climbed 2.1 percentage points to 33.1 per cent of the U.S. government debt market.

That might not sound like much, but the annual increase - which has pushed up Americans' holdings to a record US$4.3 trillion - would be the first since 2012.

Economists in a Bloomberg survey now see a 15 per cent chance the US will slide into a recession in the next 12 months, the highest estimate since 2013.

Investors in the US "are making a decision based on their outlook and it's a reflection of the economy as well as their risk aversion," Nomura's Goncalves said.

It also suggests the Fed policy makers may want to rethink their assumptions about the need to raise interest rates any time soon. While Fed chair Janet Yellen has said she still sees the economy growing enough for the central bank to raise rates by year-end, traders are skeptical. They see only a 32 per cent chance of a rate increase by December, while the odds of a March rise are at little more than a coin flip.

Some Fed officials are coming around to that view. Governors Lael Brainard and Daniel Tarullo both indicated this month the Fed should wait until clearer signs of inflation emerge.