On Sunday, when looking at the latest update of the Fed’s custody holdings of Treasuries, we noted something troubling: the number dropped sharply, declining by over $17 billion, bringing the total to $2.871 trillion, the lowest amount of Treasuries held by foreigners at the Fed since 2012.
We added that “while TIC data released this Monday will give us some much needed, if substantially delayed, data on reserve manager activity as of June, the hypothesis is that OPEC countries such as Saudi Arabia are once again quietly selling Treasuries to raise cash in an environment of low oil prices and the consequent budgetary tightness.”
After getting the Treasury International Capital (TIC) data, we can confirm that something strange is taking place in the US Treasury market, in fact something that is the complete opposite of what one would expect by looking at the relentless Indirect bidder demand in government bond auctions. Because, based on TIC data, foreign investors – both official and private – were sellers of $32.9 billion Treasury notes and bonds in June. Narrowing the selling down to just official entities, i.e. mostly central banks, but also SWFs and reserve managers, brings the total to $33.5 billion.
Contrary to our expectation that the biggest sellers would be Saudi Arabia and/or other petrodollar reliant nations, the largest sellers of Treasuries in June, based on transaction data, were China, with sales of $28.0 billion, Japan, with sales of $13.2 billion and Hong Kong, with sales of $10.8 billion. Alternatively, the largest buyer in June by far was the Cayman Islands, with purchases of $28.3 billion; this is another name for “hedge funds.” The UK was a distant second, with purchases of $5.1 billion.
As SMRA points out, the purchases of Treasuries by the Cayman Islands in June were much larger than the increase in holdings by investors there, suggesting that some of the buying was done on behalf of investors located in other countries. It appears we have a new “Belgium” on our hands, this time one where a sovereign player is using a hedge fund to accumulate positions instead of conventional London or Brussels-based bond clearinghouses.
But there was a bigger surprise: using the TIC transaction data, the change in central bank holdings in the first 6 months of 2016 amount to a whopping $192 billion liquidation, more than twice larger than the $82 billion sale in the same period in 2015. This was also the biggest 6 month selling of US debt in series history which stretches back to 1978.
Finally, the biggest surprise is when looking at the selling on an LTM basis, because adding all the central bank transactions over the past 12 months reveals a not so stealthy, make that gargantuan $335 billion in selling in the period July 2015 – June 2016, something which as the chart below shows, is truly unprecedented.
Incidentally, while the much less followed transaction data showed a historic liquidation by central banks, the TIC’s holdings data revealed an increase in Treasury holdings of $78.5 billion (including Bill holdings).
Where does the $111.4 billion discrepancy come from?
The answer is simple: the TIC holdings data are reported at market value and that often explains large discrepancies between the holdings data and the transactions data, according to SMRA. That would certainly make sense in June, when Treasuries rallied sharply after the Brexit vote. (In the TIC data, holdings are reported using month-end values.)
The impact of changes in market value is greatest on the largest holders, including China and Japan. In June, while the transactions data indicated selling by China of $32.0 billion in Treasuries in June (including bills), the holdings data showed a small reduction of $3.2 billion.
In other words, as China dumped over $30 billion in Treasuries, the market value of its holdings increased by $3.2 billion over the same period, giving the impression that it was actually buying. It wasn’t.
Similarly, while the transactions data showed Japan selling $14.3 billion of Treasuries in June, the holdings data showed an increase after adjusting for market values of $14.5 billion.
And the biggest surprise: based on the holdings data – which is marked to market – foreign holdings of long-term Treasuries were up $117.8 billion in the 12 months ended in June, compared to a decline of $241.7 billion for all foreign investors, both official and private, implied by the transactions data.
In other words, far from the conventional wisdom that foreign central banks are accumulating US Treasury holdings at a feverish pace (they may be, but only at On The Run auctions while dumping illiquid Off The Run paper), they have in reality liquidated a third of a trillion in TSYs in the past year.
Who are they selling to? The answer: private demand, in other words just like in the stock market the retail investor is the final bagholder, so when it comes to US Treasuries, “private investors” are soaking up hundreds of billions in central bank holdings. We wonder if they would do that knowing who is selling to them.
Meanwhile, the yield on US 10Y paper is almost at its all time lows.
By Tyler Durden