Bloomberg put out a story this weekend that the Treasury market was strong in spite of China “slashing” its holdings of Treasuries. It cited “robust,” deep, broad demand from other sectors as the reason for the strength.
There’s a slight problem with that view.
It is not true.
The only investor sector that has increased its buying of Treasuries over the past year has been mutual funds. Everybody else has either been cutting holdings or standing pat since the beginning of 2015. Contrary to what Bloomberg said, “Other sources of demand” are not “filling the void.” There’s no “deep and broad buyer base for Treasuries.” And according to Bloomberg, “Regulations designed to prevent another financial crisis have caused banks and similar firms to stockpile highly rated assets.” That may have been true in 2013 and 2014, but we are 8 months into 2015, and it has not been true this year.
The reason Treasuries have held up is the most simple, most basic, and what should have been the most obvious reason of all. In spite of that, Bloomberg ignored it in its “analysis.” It is because there is less Treasury supply–a lot less. Treasury net new issuance peaked in 2009 at over $202 billion in one month. It has been trending down ever since. Through mid August, net new supply is now at $46 billion. It was as low as $19 billion in April.
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Treasury auction takedown data shows that demand has fallen with supply from all types of buyers except one, mutual funds. And as you can see below, banks have taken virtually none of the new supply at auction while “brokers and dealers,” which is mostly the Primary Dealers, have steadily reduced their takedowns as supply has shrunk.
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Banks were buying in the secondary market from mid 2013 until January of this year, which obviously helped the Treasury market to rally. But they stopped buying in January, and reduced their holdings by $10 billion in June and by $15 billion in July either through sales or redemptions.
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While Treasuries have had a tiny uptick in prices in the past month, it’s not because demand is so terrific. It’s because new supply is now less than a quarter of what it was 5 years ago. It doesn’t take much demand to keep prices elevated.
The problem with tight supply being the reason for the strength in prices is that supply won’t stay low forever. When the US economy weakens, tax collections fall and the Treasury needs to borrow more, adding to new supply. The government will also need to borrow more to meet the surging requirements of the government’s entitlement programs. If demand doesn’t pick up then, the market will be in trouble.
The bad news in the short run is that Federal Withholding tax collections plunged in July and that plunge continued into last week. If that’s the start of trend reversal, the days of the Treasury Bulls and their faulty analysis of the market are numbered.
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good points. tight supply wont last.