(The opinions expressed here are those of the author, a columnist for Reuters)
By James Saft
Oct 14 (Reuters) - With Donald “You Could Make a Deal” Trump now trailing badly in the polls, the biggest threat to U.S. Treasuries may be faltering support from foreign central bank buyers.
And in a strange twist, the biggest support to Treasuries has been changes in domestic money market fund regulations taking effect today.
While the Treasury market never seemed to think Trump, whose spending and tax-cut plans would require large new borrowings, had much of a chance, his political self-immolation must be reassuring to people who lend the U.S. money.
Having the man who said “I would borrow, knowing that if the economy crashed, you could make a deal” rated as holding a 14.5 percent chance of winning the presidency, according to the influential FiveThirtyEight analysis, is good news for U.S. debt.
Trump exceptionalism aside, asset-allocation strategists at Societe Generale led by Alain Bokobza argue, moreover, that there is no clear link between recent U.S. elections and bond and equity fund flows in the U.S.
Foreign central banks, however, are showing themselves less keen to hold U.S. sovereign assets, and that can make a big difference to Treasury performance, especially as the Federal Reserve prepares to tighten monetary policy as soon as December.
“Global monetary easing has been a major driver of net inflows into U.S. bond funds since 2006,” the strategists write.
“As U.S. Treasuries are no longer supported by net buying from foreign central banks, despite an attractive yield pick-up compared to other developed market government bonds, we confirm our underweight.”
Foreign central bank holdings of U.S. Treasuries reached a peak of $3.03 trillion in July 2015, but have fallen by more than $200 billion since.
The most recent Fed custody data showed a fall of $7 billion in Treasuries held by the Fed for foreign official and international accounts in the week ending Oct. 12, or $162 billion in the past year. Fed custody holding are about three quarters of foreign central bank overall investments in Treasuries, giving the data value as a directional steer.
Much of that is due to China, whose Treasury holdings as of July were at their lowest since January 2013, in part due to sales to fund defense of the yuan amid continued outflows.
China has recently allowed the yuan to weaken markedly, but it is fair to expect continued pressure on it, both in anticipation of future weakening and downbeat Chinese economic fundamentals.
An unexpectedly steep 10 percent fall in China’s exports in September compared to the year before will only add to pressure.
This implies an ongoing period of Chinese sales of Treasuries, which may tend to send yields higher.
Other traditional big holders and buyers of Treasuries like Saudi Arabia and Japan have also been lightening up, the former to plug budget shortfalls due to the low price of oil and the latter as Japanese banks sought dollar liquidity to dodge deeply negative interest rates at home.
New money market fund rules taking effect Oct. 14 have provided a useful counterweight to foreign central bank selling of Treasuries. So-called Prime Funds, which tend to hold short-term corporate debt, now must let their price fluctuate to reflect the value of their holdings, whereas before they were allowed to peg shares to $1.
That’s prompted a flood of money out of Prime Funds and into funds which invest solely in government securities. Whereas Prime Fund and government fund assets were about the same in March, according to Investment Company Institute data, government funds, with over $2 trillion, are now more than four times larger. All told, government money market funds have increased by about $850 billion since the beginning of the year.
The question is the extent to which money market fund buying has masked foreign central bank selling. Given that most sophisticated institutional investors will have front-run the changes in regulation, there may not be much structural shift in holdings yet to come. Unless investors generally decide they want to hold more cash, the extraordinary bid from money market funds for government debt may be at an end.
So unless Japanese rates rise, the price of oil goes up enough to help Saudi Arabia or China’s economy turns around, government bonds will face a headwind in coming months.
Not the kind of headwind they might face in the event the U.S. was led by someone who thinks “full faith and credit” is a marketing slogan rather than a pledge, but significant nonetheless.
Inflation may stay low, the Fed may well stay on hold or only hike once, but Treasuries will have other things to worry about. (Editing by James Dalgleish)