Indirect Bidders Are Fleeing The Short Bond
Treasury International Capital data provides an interesting glimpse into foreigners' bond purchasing habits: since the beginning of Quantitative Easing (April TIC data) through October 31 (the last publicly available data point for TIC), foreigners have bought a total of $236 billion in Treasury securities, which includes Bills, Bonds, Notes, TIPS and Cash Management Bills (from total holdings of $3.262 trillion in April to $3.498 trillion in October). What is known is that in April total marketable debt consisted of $1.988 Trillion in Bills, $3.822 Trillion in Notes and Bonds and $530 Billion in TIPS, for a total of $6.34 trillion. By October, this number had shot up to $4.5 trillion in Notes and Bonds, $567 Billion in TIPS, while Bills had been reduced to $1.85 trillion for a total of $6.925 trillion.
Zero Hedge has gone through every single Bill, Bond and Note TreasuryDirect auction and compiled the data for Indirect Bid auction take down numbers. We observe that the gross take down for Indirect bidders for Bonds and Notes amounts to a substantial $577 billion in the April-October period, and estimating redemptions of $162 billion, implies foreigners purchased a net amount of $414 billion in Bonds and Notes (we exclude TIPS as the number is largely nominal for the purpose of this exercise). Yet as we pointed out, TIC indicates that the total number of UST holdings only went up by $233 billion, implying foreigners (aka Indirect Bidders) were net sellers of $181 Billion in Treasury Bills. And this occurred at a time when there was still some modicum of yield on the short-end of the curve. With Bill yields now at record lows, and a record steep yield curve as a result, will foreigners ever step in to fill a void which apparently has been filled exclusively by Primary Dealers and the Federal Reserve in the attempt to keep the curve at record steepness? If yields continue being so low that only domestic banks, which benefit from the steep curve, are buying the short-end, this leaves a major question mark for the future.
Zero Hedge, using TreasuryDirect data, calculated monthly Indirect take downs beginning in April through the end of October (the last date for which TIC provides total foreign holdings). The monthly auction data for all Bonds and Notes (excl. Bills, CMBs and TIPS) is as follows:
Out of a total $1.215 trillion in Bonds and Notes auctioned off in April-October, Indirects were responsible for taking down $576 billion. The average indirect take down of any given auction is 47.5%, implying that indirect bidders, aka foreigners, are responsible for nearly half of the end demand for any given Bond/Note auction.
Next, using Daily Treasury Statement data for Treasury redemptions, we calculated that in the April thru October period, $342 billion in Notes and Bonds matured/redeemed by the Treasury. We estimate the amount of Indirect redemptions using the same ratio of take down at about 47.5%, to reach a number of $162 billion. Netting out this redemption amount from the total indirect take down of $576 billion, we obtain an estimate for Indirect Purchases net of redemptions in the 7 month period of $414 billion. Net Indirect Bidder activity for April thru October is seen on the following chart:
Using comparable TreasuryDirect data for Bills and Cash Management Bills (CMBs) we obtained the following breakdown of gross purchases for Indirect and Total buying take downs. Notably, the average take down ratio over the 7 month period is noticeably lower at 38.5%. Already, the demand interest is markedly lower by 900 basis points (and this ignores any redemption netting).
Likewise, to estimate Net Indirect take downs, we determined the total amount of Bill redemptions using DTS data, and allocated a portion to indirects using the same process as above: using the take down ratio of 38.5% in reverse. The conclusion: Indirects took down $1.367 trillion in Bills while redeeming $1.523 trillion, for a net negative balance of $156 billion.
Combined, these two data sets yield the following observations for Net Indirect Treasury Activity in the April - October period:
The cumulative sum of all monthly net data results in $257 billion. As a reminder, according to TIC, the total change in all foreign holdings in the comparable time period was $236 billion. We are confident that if we had refined our redemption assumptions, the two data series would overlap.
In summary, while Indirect Bidders have continued to express an interest in US Treasury holdings, the duration profile of their portfolio has shifted dramatically, with a rotation of nearly $260 billion from short bonds into the dated side of the curve. This is how the comparison between the TreasuryDirect primary data and the TIC data looks graphically.
The record steep yield curve is having the desired impact of pushing Indirect Bidders away from the short end of the curve, and, contrary to conventional wisdom, is forcing foreigners to buy further down, or rather, right, the curve. This begs the question: with foreigners so obviously shunning the Bill space, who is it that provides the massive take down interest each and every Bill auction to allow short rates to be in a record tight range? The answer is obviously Primary Dealers, and the broader banker community, which courtesy of Q.E., are the only ones who are able to take advantage of the record curve steepness, and load up on cash at close to zero rates and subsequently lend it out or leverage this new capital via traditional fractional reserve mechanisms.
In very much the same way that near zero money market rates are expected to push retail investors out of safe cash-equivalent investments, so the record steepness is increasingly forcing ever more foreign lenders to go to the right of the curve in order to collect yield.
The question remains: with still a record high ratio of Bills to all other marketable government securities, will the government be able to push enough investors out of the relative safety of the short end into riskiness of "higher" yielding bonds, especially with increasing speculation that inflation may finally be around the corner. If this recent trend of shifting away from Bills into Bonds and Notes by Indirects is any indication, then inflation fears are indeed significantly overdone. Yet if in fact the Fed succeeds in stirring up the money multiplier hornet's nest, and banks finally do turn on the small and middle-business lending spigot, and inflation does intensify, the rush out of Bills will be taken up by everyone, not just Indirect, which would, in our opinion, result in a substantially overall flattening of the curve. This in turn would force all those asset managers who are positioned comfortably in expectation of further record steepening, to rush through the exits and cover their positions, thus create a feedback loop which could potentially cause a near flat curve at some point in the future. In the meantime, the risk of this occurring is minor, and with the 2s30s still at record steepness of around 375, we anticipate that ever more momentum chasers will continue jumping on the most popular trade of the year until such time as the spirit of Volkswagen rears its ugly head once again.