Top buyers of US bonds all bailing out at once

NEW YORK - Everywhere you turn, the biggest players in the US$23.7 trillion (S$34 trillion) US Treasuries market are in retreat.

From Japanese pensions and life insurers to foreign governments and American commercial banks, where once they were lining up to get their hands on United States government debt, most have now stepped away.

Then there is the US Federal Reserve, which a few weeks ago upped the pace that it plans to offload Treasuries from its balance sheet to US$60 billion a month.

If one or two of these usually steadfast sources of demand were bailing out, the impact, while noticeable, would likely be little cause for alarm. But for every one of them to pull back is an undeniable source of concern, especially coming on the heels of the unprecedented volatility, deteriorating liquidity and weak auctions of recent months.

The upshot, according to market watchers, is that even with Treasuries tumbling the most since at least the early 1970s, more pain may be in store until new, consistent sources of demand emerge. It is also bad news for US taxpayers, who will ultimately have to foot the bill for higher borrowing costs.

Treasuries dropped again on Tuesday in Asia. The yield on 30-year US bonds jumped nine basis points to 3.94 per cent, the highest since 2014, while that on 10-year notes climbed seven basis points to 3.95 per cent.

To be sure, many have predicted Treasury market routs over the past decade, only for buyers (and central bankers) to swoop in and support the market. Indeed, should the Fed pivot away from its hawkish policy tilt as some are wagering, the brief rally in Treasuries last week may be just the beginning.

Analysts and investors say that with the fastest inflation in decades hamstringing the ability of officials to loosen policy in the near term, it is likely to be much different this time.

The Fed, unsurprisingly, represents the largest loss of demand. The central bank more than doubled its debt portfolio in the two years to early 2022 to in excess of US$8 trillion.

The sum, which includes mortgage-backed securities, may fall to US$5.9 trillion by mid-2025 if officials stick with their current roll-off plans, Fed estimates show.

While most would agree that lessening the central bank's market-distorting influence is healthy in the long run, it nonetheless is a stark reversal for investors who have grown accustomed to the Fed's outsized presence.

"Since the year 2000, there has always been a big central bank on the margin buying a lot of Treasuries," Credit Suisse investment strategist Zoltan Pozsar said during a recent live episode of Bloomberg's Odd Lots podcast.

"We are basically expecting the private sector to step in instead of the public sector, in a period where inflation is as uncertain as it has ever been," Mr Pozsar said.

Still, if it were just the Fed - with its long-telegraphed balance sheet run-off - reversing course, market angst would be much more limited. It is not.

Prohibitively steep hedging costs have essentially frozen Japan's giant pension and life insurance companies out of the Treasury market as well. Yields on US 10-year notes have slumped well below zero for Japanese buyers who pay to eliminate currency fluctuations from their returns, even as nominal rates have jumped above 4 per cent.

Hedging costs have surged in tandem with the US dollar, which has climbed more than 25 per cent in 2022 versus the yen, the most in data compiled by Bloomberg going back to 1972.

As the Fed has continued to boost rates to tame inflation in excess of 8 per cent, Japan in September intervened to support its currency for the first time since 1998, raising speculation that Tokyo may need to start selling its hoard of Treasuries to further prop up the yen.

It is not just Japan - countries around the world have been running down their foreign exchange reserves to defend their currencies against the surging dollar in recent months.

Emerging-market central banks have trimmed their stockpiles by US$300 billion in 2022, International Monetary Fund data shows.

This means limited demand at best from a group of price-insensitive investors that traditionally put at least 60 per cent of their reserves into US dollar investments.

Citigroup has flagged concern that the drop in foreign central bank holdings may set off fresh turmoil, including the potential for so-called value-at-risk shocks when sudden market losses force investors to rapidly liquidate positions.

BLOOMBERG