The large presence of “insensitive buyers” of US government bonds has resulted in “artificially low volatility” in the asset class since 2011, James McAlevey, fixed income portfolio manager at Aviva Investors, told a press briefing on Wednesday.
“Demand for these bonds has been insensitive because institutional buyers like the Fed, foreign central banks and foreign institutional investors bought US Treasuries anyway, regardless of the valuations,”, he added. Foreign buyers now own as many US Treasuries as domestic investors, and the Fed’s share of total holdings has also increased.
“Foreign institutional investors bought US treasuries because of the low yields in their home markets and central banks did it because they were building up their reserves,” said McAlevey.
Dollar hoarding reverses
But now, for the first time in decades, we have approached a point that foreign investors are reducing their Treasury holdings.
“They again are starting to find attractive yields on offer domestically and, importantly, the reserve built-up of foreign central banks has stopped.”
Global foreign currency reserves, most of which are held in dollars, grew from roughly $8trn in 2009 to $10.5trn in 2016, according to World Bank data. China, Japan and Saudi-Arabia have stopped increasing their foreign currency reserves, which in fact are now at marginally lower levels than in 2014.
At the same time as natural foreign appetite for Treasuries is drying up, the Fed is also preparing to start reducing its balance sheet. In combination with the decreased attractiveness of the dollar, this will lead to a strong reduction in “insensitive demand” for US government bonds.
The slack will have to be picked up by domestic buyers, who are more sensitive to bond prices and valuations, says McAlevey. While volatility of equities could remain low for an extended period of time, that of US government bond yields will “go up to normal levels” as these long-term changes are taking shape, he concluded.