No two periods are alike but what is starkly different now from the GFC is that foreign investors (including foreign central banks – FCBs) were sellers of USTs during the early days of COVID-19 induced financial market stress. This was likely one of the reasons why the Fed stepped in to buy USTs in record amounts. However, the launch of swap lines and the FIMA repo facility helped reduce the need for FCBs to sell USTs to raise dollars.
That said, there has been a trend in place for years now where foreign official accounts have not been meaningfully increasing their holdings of USTs. Its early days post the initial shake up due to the COVID-19 shock, but will FCB demand for USTs ever return in size again, it’s a key question for the market. And will innovations such as the swap lines and repo facility be sufficient versus FCBs having to boost their stock of USTs.
Foreign Official UST Holdings Have Been Relatively Flat Since 2015
Recently I published an article on how the broader foreign investor base of USTs have seen their dominance fade as the Fed and domestic accounts have stepped in to underwrite the expanding US government debt loads. This time we look at the UST holding levels for the foreign official (aka central banks). Chart 1 shows the breakdown of UST holdings (between longer-term USTs, greater than 1-year, versus T-bills) as per TIC data.
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No two periods are alike but what is starkly different now from the GFC is that foreign investors (including foreign central banks – FCBs) were sellers of USTs during the early days of COVID-19 induced financial market stress. This was likely one of the reasons why the Fed stepped in to buy USTs in record amounts. However, the launch of swap lines and the FIMA repo facility helped reduce the need for FCBs to sell USTs to raise dollars.
That said, there has been a trend in place for years now where foreign official accounts have not been meaningfully increasing their holdings of USTs. Its early days post the initial shake up due to the COVID-19 shock, but will FCB demand for USTs ever return in size again, it’s a key question for the market. And will innovations such as the swap lines and repo facility be sufficient versus FCBs having to boost their stock of USTs.
Foreign Official UST Holdings Have Been Relatively Flat Since 2015
Recently I published an article on how the broader foreign investor base of USTs have seen their dominance fade as the Fed and domestic accounts have stepped in to underwrite the expanding US government debt loads. This time we look at the UST holding levels for the foreign official (aka central banks). Chart 1 shows the breakdown of UST holdings (between longer-term USTs, greater than 1-year, versus T-bills) as per TIC data.
As you can see from the chart, the majority of the growth in UST holdings for the foreign official sector took place between the ten-year period of 2004-2014. After that period, we have seen overall holdings, especially in the longer-term USTs, basically flatlined up until a recent bump last year. At the start of that period it was Japan and its massive FX interventions that lead the growth but then China, along with other EM countries, saw their FX reserves expand in a meaningful way for the balance of that period.
And if you zoom in further (as shown by the red box outline in the middle of the chart) most of the UST buying took place in a three-year period after the GFC (March 2009 through March 2012). There was a big jump initially via T-bill purchases in the fall of 2008 but as those short-term securities rolled off (along with FX swap line usages, which is a separate topic but somewhat related, see below) the foreign official accounts turned to buying what the Fed was acquiring – l/t USTs. Since then a combination of foreign official accounts buying alternative USD assets (and signs of some USD diversification) has resulted in minor net new UST purchases since 2015.
Fed’s FX Swap Lines: To Fade to Zero or Can They Come Back Into Use?
Meanwhile in this next chart we study the USD swap lines that the Fed put into place during the 2008-09 GFC and most recently tweaked in response to COVID-19 impact on markets and potential dollar shortages. There are two ways to read this chart. One is to see the total usage that took place over a 48-week period, from high to low (which shows that over time the lines are reduced). The second way is to see the 24 weeks pre and post any sort of notable decline in the USD outstanding balances.
I highlight these two different interpretations for the following reasons. In Early 2008 there was some minor usage of the FX swap lines and then they were netted down for a few weeks, however, that proved to be a head fake as eventually the GFC crisis worsened and these USD swap lines were tapped massively into and throughout the Fall of 2008. Second reason is that these swap lines were not used as much as some of us feared (given that the world is now even more short USD funding vs 2008).
The lines are also being unwound and if they continue at the scheduled pace, by September the FX swap lines could return back to zero if there are no further flareups. I am posing way too many questions, but can markets avoid a wave 2 of acute USD funding needs? If not, these lines could be tapped again. The good news is at least with the lines in place it should dampen vol in short-term funding, even if usage were to return.
So, Will Foreign Official Investors Go Back to Driving UST Demand?
The multi-trillion-dollar question is, will foreign official investors come back in a size that is meaningful enough to provide a helping hand to Uncle Sam? The jury is still out on that one. As we can see in Chart 1, post the GFC experience there was strong buying of USTs by the official sector as FX reserves grew. However, the world ahead does not look like that is set to repeat. For one, we still have unresolved trade negotiations with China, and given how much debt the US is producing the global trend to diversify from the dollar could continue resulting in the UST market increasingly being financed domestically by US investors and the Federal Reserve.
And for a less nefarious reason, unless the Fed turns off these innovations to the FX swap lines and closes down the FIMA repo facility, the foreign official account base now has a way to access USD liquidity, thus they might not need to build ever expanding UST portfolios. The good news is that there should be less panic-based selling of USTs in the next crisis too.
George is a twenty years fixed income veteran. Over that time he has been an active participant on the research and investment side covering rates, structured products and credit. He worked both on the buy-side and sell-side. He can be reached here.
(The commentary contained in the above article does not constitute an offer or a solicitation, or a recommendation to implement or liquidate an investment or to carry out any other transaction. It should not be used as a basis for any investment decision or other decision. Any investment decision should be based on appropriate professional advice specific to your needs.)