One topic that has caught the mainstream media's attention is the recent surge in Direct Bid take down participation in Treasury auctions, which as we pointed out previously (3 Year auction, 10 Year auction), has jumped from sub 10% average well into the double digit arena. Today the Financial Times dedicates an entire article to questioning just who may be "bucking the trend" in opinions and going all out in their purchases of Treasuries as direct bidder.
Market participants say the unusually high level of direct bidding suggests that a large investor is looking to accumulate Treasuries without alerting the primary dealers on Wall Street to its intentions.
"It appears to us that someone is trying to hide their apparent interest in owning these auctions from the rest of the market," said David Ader, strategist at CRT Capital.
Rick Klingman, managing director at BNP Paribas, said: "It is unusual to see such a spike in the direct bid and I would imagine it is one big bidder. There is no way we will find out who it is, not now, or ever."
We would disagree with Mr. Klingman. We also would disagree with Mr. Santelli, that the mysterious "direct bid" is merely the Fed doing an undercover Quantitative Easing. We all know that the Federal Reserve purchasing treasuries does so either directly (via Q.E., although that is now over) or though its Primary Dealer lap dogs, who come hell or high water will provide a bid floor as a failed auction is the number one "black swan" that will promptly set the whole house of cards tumbling faster than Lloyd Blankfein can yell Bank Run in the middle of a Group of 30 meeting. Primary Dealers will always satisfy whatever buying interest the Fed informs them to indicate. Which makes us believe we have to look offshore for the Direct Bidder.
What do we know? This week the PBOC will release it latest, Q4 FX reserve data. Estimates put the new total of reserves at around $2.4 trillion, an increase of about $120-$130 billion from Q4, when the number was $2.272 trillion (when the number grew by $140 billion over Q2, respectively).
Yet as we have pointed out repeatedly through TIC data, China's UST holdings have increased by a mere $35 billion since April, a period of time when the country's FX reserves grew by a whopping $363.35 billion, or ten times the disclosed Treasury holdings, which as of the most recent number were at $799 billion.
Now traditionally the relationship between FX growth and TSY holdings in China has not been a direct one, as the Chinese FX managers go to big lengths to hide their UST purchases. Yet from a trade balance perspective, the stability of the CNY versus the USD, at a time when the country continues to amass a major trade surplus (granted less so in 2009 than before, but still a sizable amount) is indirect evidence that China continues to buy US debt, even if purchases do not show up in TIC data.
The question then naturally becomes: how is China hiding its purchases. As Stone % McCarthy indicates, "The usual suspects for channeling backdoor purchases of Treasuries are the UK, Hong Kong, the Caribbean Banking Centers, Switzerland and Luxembourg. Taken together, additions to Treasury holdings for this group increased USD110bn over the period April 2009 - October 2009, with the bulk of the purchases coming from the UK and Hong Kong."
Furthermore, if China has indeed entered a very covert mode of stealth TSY purchasing, it would likely shun the indirect bid altogether and begin doing so at the Direct Bidder level. Whether this means that China is providing back door funds to a domestic asset manager to purchase bond exposure we do not know, although that would surely be one way of goosing the "Direct" bid.
Additionally, there is no doubt that China would have little to no interest in the long-end of the curve. Assuming the above theory is at least partially value, this would be indeed confirmed as the direct bid take down in the just completed 30 Year was a meager 4.9%: orders of magnitude less than its participation in the 3 and 10 year auctions earlier this week.
Which begs the question: why is China so intent to hide its holdings in US Treasuries from being exposed by traditional channels such as TIC data? And, the corollary to this, has the Fed blessed this covert accumulation? If the answer to the last is yes, this presents a very troubling conclusion: the Fed's Treasury Quantitative Easing has now been offloaded to China.
It is no secret that the two main beneficiaries of the current Keyenesian experiment in extend-and-pretend are China and the US - should there be a failed auction it would certainly destroy the economic recovery in the US; it would reverberate even more in China, whose currency has long been pegged to the US, forcing many to say that China is merely yet another state of the US (or alternatively, that the US is now just a vassal state of China).
With China FX reserve continuing to grow at a massive clip of about half a trillion per year, the country is stuck with great amounts of dollars that it does not need, yet can not sell without forcing a devaluation of the dollar. It is thus forced with only one possible "investment decision" - buying Treasuries. Yet due to reasons still undetermined, it is doing without notify the broader public. To assume that China has grown it FX reserves by a factor of 10 times what its UST purchases have been in the past half year is laughable.
Which is why we make the claim that the Fed has now informally offloaded the Treasury portion of Quantitative Easing to China, which does so via the elusive Direct Bid. It also explains why the Fed has generically been much less worried about TSY purchases under Q.E. (a mere $300 billion out of a total $1.7 trillion in monetization). It does beg the question of just how much Chinese holdings of US Debt truly are, as this number is likely hundreds of billions higher than the disclosed $799 billion.
Of course, if this is proven, it will expose the fact that China's and the US' central bank (and broadly economic) fates are tied closer than ever. Furthermore, monetary policy in one country will immediately be met with a comparable response by the other. Additionally, if there is indeed an implicit understanding between Bernanke and his Chinese colleagues, it means that not only the housing market (via Agency and MBS security purchases), but the Treasury market as well, are both manipulated beyond recognition and implies that broad securities are massively overvalued due to the stealth purchasing of core "riskless" assets by the US and China, as investors look higher in the cap structure for yield. Lastly, implications for world trade are great, as Asian countries will have to deal not only with the Chinese behemoth, which will constantly seek to keep its currency as low as possible, thus exacerbating the rest of Asia's foreign trade balances, but that of the US itself. The immediate implication is that China (or the US for that matter) will likely not reflate their currencies out of their own volition any time in the foreseeable future. Look for a much weaker dollar in the coming months.