There are a number of market beliefs that develop over time which end up being accepted without question. One of those givens is that foreign investors hold the vast majority of the marketable UST debt outstanding. However, take a closer look at the data and you find that was only really true for a brief 10-year window in time, between 2007 and 2017.
Since then, domestic investors (including the Fed, which is becoming a dominant player in the UST space for numerous reasons) have taken the lead. Now you might say it’s unfair to include the central bank. Fine. Even so, there is now roughly equal ownership between foreign and domestic investors of UST holdings. We explore how this came about.
The Evolution of UST Holders vs Major Events Since 1971 is Revealing
To really understand how we got to where we are, we need to look back over the last fifty years or so to see how the ownership structure of the UST market evolved. For this exercise we used the Z1 data marketable UST debt ownership and took the rest of the world data along with the Fed’s holding levels versus the total to calculate the domestic ratios. Note it’s a simple analysis that captures the trends even if the exact ratio may differ slightly from what the more granular data sets may suggest.
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There are a number of market beliefs that develop over time which end up being accepted without question. One of those givens is that foreign investors hold the vast majority of the marketable UST debt outstanding. However, take a closer look at the data and you find that was only really true for a brief 10-year window in time, between 2007 and 2017.
Since then, domestic investors (including the Fed, which is becoming a dominant player in the UST space for numerous reasons) have taken the lead. Now you might say it’s unfair to include the central bank. Fine. Even so, there is now roughly equal ownership between foreign and domestic investors of UST holdings. We explore how this came about.
The Evolution of UST Holders vs Major Events Since 1971 is Revealing
To really understand how we got to where we are, we need to look back over the last fifty years or so to see how the ownership structure of the UST market evolved. For this exercise we used the Z1 data marketable UST debt ownership and took the rest of the world data along with the Fed’s holding levels versus the total to calculate the domestic ratios. Note it’s a simple analysis that captures the trends even if the exact ratio may differ slightly from what the more granular data sets may suggest. Also realize these are ratios of totals that have been increasing in size (and only saw a brief stability in debt levels during 1999/2001).That said, the following chart is full of details and historical turning points that I implore you to study closely to really understand the evolution of UST investor base.
As you can see in Chart 1, there are a number of key observations that jump out. First, it was primarily domestic investors that owned the UST market coming out of WW2 and through President Nixon’s 1971 closing of the Gold Window. The gentle glide lower in private domestic ownership was offset basically by the Fed as they became more active during the late 1960s-1970s (a period to which some have compared recent history, for what it is worth). Then of course the Nixon shock changed this materially.
Foreign holders of USTs have had two distinct periods where they became important drivers of the UST market. The break from a gold-linked dollar further entrenched the dollar as the reserve currency in the years that passed. We see that clearly by the increase in UST holdings in the 1970s. The second time we see an increased foreign ownership is the most recent period starting from the mid-1990s through the 2008 GFC event.
We can actually break this era down into two periods. One period when the Japanese Yen was re-rated leading to Japan’s ministry of finance buying more USTs as a result, and at the same time there was a further a internationalizing of trading Treasuries by the hedge fund community (you can conclude that by the rise in Caribbean and UK holdings of USTs then, and we are well aware of the jurisdiction issue and double counting matter).
The second major push up in the rest of the world’s holdings of USTs was in the decades before and after the GFC. This came as a result of one of the largest booms in oil prices, which saw large numbers of US dollars accumulate overseas, but also at the same time emerging market nations were intervening in FX markets to keep their currencies on the weaker side for export purposes. During this period, UST deficits started to re-accelerate. And it was true that most of the new issuance was being purchased by foreign investors, which helped establish this narrative that foreign investors were the only game in town in the UST market. All that buying pushed up foreign investors into the majority from 2007-2017.
The Fall and Rise of the Domestic Holders of USTs
If we leave the 1970s global readjustment aside, the domestic holders of USTs only really started to change shape in the 1990s. As seen in the chart, there were a number of initiatives (and a few that I left out like allowing leverage to creep into the banking system, etc.) that made lending laxer and saw banks shift their focus to credit versus holdings bonds. And, at the same time, new investment alternatives and higher returns in credit and equities caught the focus of mutual funds and pension investors. In a nutshell, domestic investors took on more risk and moved away from USTs.
There was a brief spike up post the GFC event as US investors became risk-averse for a few years, but that didn’t last long. It took the start of BASEL 3 (liquidity coverage ratio) to kick-off the demand for USTs from the domestics again. There was also a big push into passive investing/risk-parity style approach that naturally resulted in more local UST buying as well. That, plus a general higher rate environment towards the end of the last decade, saw domestic investors get to equal weight versus foreigners.
Conclusion
Post Q1 volatility, in many ways the bond market is at an equilibrium now with the Fed in the middle of the tug-of-war between foreign and domestic holders of USTs. The Fed has been operating under this concept that its UST purchases are strictly for ‘market function’ purposes, but that is in many ways code for them helping to maintain balance in supply/demand.
Domestic accounts are generally not fans of USTs given their low yields, and the events since last September’s repo crisis proves that when local balance-sheets gets tight it can become disruptive for broader markets. And unless foreign investors all of sudden start to intervene more in FX markets and/or see commodity prices rise meaningfully, they are no longer sitting at the top of the stack in what happens to the US bond market either.
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.)