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The rest of the world can’t seem to get enough of America’s debt.
Japanese bond buyers have ramped up their purchases of U.S. Treasurys even though the U.S. is set to incur a budget deficit of around $4 trillion this year, with new stimulus packages debated in Congress set to further widen this shortfall. Their increased appetite may help refute concerns shared by fiscal hawks that foreign investors may eventually decide to stop footing America’s bills.
“The sharp increase in US Treasury issuance should find support not only from the Fed, but also from foreign buyers,” said Antoine Bouvet, senior rates strategist at ING, in a note.
Japanese investors snapped up 5.4 trillion yen ($50.4 billion) of Treasurys and government-backed mortgage bonds in March, based on data from Bank of Japan.
This represents the largest monthly inflows on record since the data was first compiled in 2005, according to Societe Generale.
Analysts attributed the robust demand for the record large Treasury auctions held this week to overseas buyers. Despite the Treasury increasing the 10-year note auction TMUBMUSD10Y, 0.621% by another $5 billion on Wednesday, the notes were sold at a record low yield of 0.70%.
See: Analysts warn a deluge of new U.S. government debt could spark bond-market tantrum
In theory, growing fiscal deficits and increased borrowing can hurt a country’s creditworthiness and overwhelm bond buyers who may have a limited capacity to absorb new debt. Combined with the fact that the U.S. depends on the kindness of strangers to buy its bonds, budget hawks have periodically worried that the U.S.’s fiscal profligacy would be punished.
Yet in practice, the U.S.’s “exorbitant privilege” as the issuer of the world’s reserve currency, which underpins international trade and the global financial system, has ensured continued flows into Treasurys. Export-dependent countries like Germany, Japan and China recycle their trade surpluses into U.S. dollar denominated debt, pushing down U.S. borrowing costs.
And the deep liquidity offered by Treasurys have made the U.S. government bond market the financial haven of choice among overseas pension funds, insurance companies and investors.
This safe-haven status was again highlighted when the economic uncertainty created by the COVID-19 pandemic pushed the yield for the 10-year U.S. government bond to a record low of 0.32% in early March.
Since then, the benchmark yield has drifted between a range of 0.50% to 0.75%. The 10-year traded at 0.62% on Thursday.
But analysts suggest beyond these structural and lasting factors underpinning the U.S. bond market, a sharp drop in the cost of hedging fluctuations in the greenback have made it more lucrative for foreign investors to buy Treasurys. The Federal Reserve’s move to cut its policy interest rate to zero in mid-March narrowed the gap between U.S and interest rates abroad, which, in turn, reduced the cost to strip out the currency risk.
For the first time since 2018, a Japanese pension fund would have earned higher returns from buying Treasurys and hedging for currency risk than by owning its own country’s government bonds.
This coincides with the decision by Japan’s $1.5 trillion Government Pension Investment Fund, the largest public retirement plan in the world, to increase its holdings of foreign bonds. Much of this demand is likely to flow into Treasurys, said Bouvet.
