The Federal Reserve ended its quantitative easing program, but Treasury bond securities and related exchange traded funds won’t suddenly fall out as foreign investors help pick up the slack.
Year-to-date, the iShares 7-10 Year Treasury Bond ETF (NYSEArca: IEF) rose 7.5%, iShares 20+ Year Treasury Bond ETF (NYSEArca: TLT) increased 19.7% and PIMCO 25+ Year Zero Coupon US Treasury (NYSEArca: ZROZ) jumped 34.6%. [The Secret and Risk Behind Two High-Flying Bond ETFs]
Investors have put up bids for $5.54 trillion in government debt at auctions this year, or 3 times the amount sold and higher than the 2.87 bid-to-cover ratio last year, Bloomberg reports. In comparison, the bid-to-cover ratio never topped 2.65 prior to the financial crisis.
“There may not be enough Treasuries to go around,” William O’Donnell, the head U.S. government bond strategist at RBS Securities Inc., said in the article. “We watched the Fed slow its purchases and yet rates are still falling.”
Even as the Federal Reserve winds down its appetite for U.S. Treasuries, foreign central banks, insurers and pensions could step in to fill the void and keep U.S. borrowing costs low. While most fixed-income observers argued that rates would spike and Treasuries would slump once the Fed wound down its buying spree, foreign central banks and other institutional investors have increased demand for safer U.S. debt. [Treasury Bond ETFs Find Further Support From Pensions]
Specifically, foreign investors acquired more Treasuries in August than other month this year, accounting for a record $6.07 trillion of the Treasury bonds market.
Barbara Cummings, the director of fixed income at Boston Private Wealth Management, argues that diminished global demand and geopolitical risks in the emerging markets, notably in Russia and the Middle East, will help push foreign investors into U.S. bonds. Meanwhile, quantitative easing in Europe and Japan makes U.S. yields relatively more attractive.
“If you look at government bond yields around the world, the U.S. is one of the higher yielding and certainly the highest quality.” Cummings, said in the article.
For instance, IEF, which has a 7.64 year duration, has a 1.97% 30-day SEC yield. The yield on benchmark 10-year U.S. Treasuries is 2.38%. In comparison, the 10-year Japanese government bonds yield is 0.45% and the 10-year German bund yield is 0.85%.
The yield on 30-year Treasuries is 3.13%, compared to 30-year Japanese bond yield of 1.59% and 30-year German bund yield of 1.78%. TLT, which has a 17.19 year duration, has a 2.83% 30-day SEC yield and ZROZ, which has a 27.34 year duration, has a 2.94% 30-day SEC yield.
Moreover, supporting the continued demand in U.S. government bonds, slow wage growth has kept a lid on consumer spending, and the low inflationary environment has kept fixed-income assets attractive – high inflation, on the other hand, would erode the real yield on bonds. Last week, a government report revealed inflation slowed to 1.4% in September, below the Fed’s 2% target.
“We are seeing continued low yield levels despite tapering because we still have no inflation pressure,” Jeffrey Klingelhofer, a money manager at Thornburg Investment Management Inc., said in the article.
For more information on the U.S. Treasuries market, visit our Treasury bonds category.
Max Chen contributed to this article. Tom Lydon’s clients own shares of TLT.
The opinions and forecasts expressed herein are solely those of Tom Lydon, and may not actually come to pass. Information on this site should not be used or construed as an offer to sell, a solicitation of an offer to buy, or a recommendation for any product.