Treasuries For Sale

For years pundits have warned us that foreign investors, specifically China, were going to look elsewhere for a place to invest their capital. Some have said that low interest rates, a weaker dollar and record budget deficits have resulted in the day of reckoning drawing near. However, data indicates that foreign buying of U.S. treasuries has increased.

Bloomberg News reports:

“Investors outside the U.S. have boosted their holdings of longer-maturity Treasuries to the highest level since the credit markets froze in 2008, helping curb rising yields amid concern inflation is accelerating.”

“International buyers held 90 percent of their $4.44 trillion of U.S. government debt in notes and bonds as of December, the same as in September 2008 when Lehman Brothers Holdings Inc. collapsed, Treasury data released last week show.”

Market participants, such as Pimco’s Bill Gross and Sun Trust’s Andy Richman express views that buying treasuries at these yield levels given that the economy is healing and inflation pressures are building (I think the are overstating here), is unwise. I agree with them Investors would be unwise to buy long-dated treasuries at these levels, but foreign central banks are not investor. They have a different mission.

As I have written ad nauseum, foreign central banks and export businesses are flush with dollars from foreign trade. Central banks are tasked with “managing” exchange rates between their home currencies and the dollar. They have no choice but to buy treasuries. For duration and liquidity purpose, the 10-year note is the vehicle of choice.

Inflation fears are largely overblown. Without wage increases, higher oil prices can only have a limited effect on inflation. In fact, higher oil prices are self-limiting. At some point, cash strapped consumers will be squeezed. First they will defer discretionary purchases. Then they will spend more frugally on necessary items. Then they will cut back as much as possible on fuel purchases. The result will be significant headwinds for the economy, probably not enough to cause a recession, but enough to keep inflation well under 3.00% and GDP under 4.00%.