Japan is poised to pass China as the largest U.S. creditor for the first time since August 2008 as growing demand for U.S. government debt reduces borrowing costs for President Barack Obama as the deficit swells.
Japan added $55.3 billion of Treasuries this year, swelling its holdings 7.2 percent to $821 billion, Treasury data show. China, which overtook Japan in September 2008, cut its stake by $48.1 billion, or 5.4 percent, to $846.7 billion. Japan made its biggest purchase in 10 months in July, just after China cut its position by the most on record.
The purchases show no slowdown in demand for America’s debt, helping to limit rates on everything from corporate bonds to mortgages as global economic growth slows and the deficit expands to $1.4 trillion. Treasury yields average 1.31 percent, down from 5.21 percent at the start of the financial crisis in mid-2007, Bank of America Merrill Lynch index data show.
“The U.S. still has the confidence of investors,” said Carl Lantz, the head of interest-rate strategy in New York at Credit Suisse Group AG, one of 18 primary dealers of U.S. government securities that trade with the Federal Reserve. “When you’re a reserve manager, it’s not about return on investment, it’s return of investment.”
Even with China’s sales, foreign holdings of U.S. debt have increased $374 billion this year, or 10 percent, to $4.07 trillion as of July, Treasury data show. At that pace, net purchases would rise to $641 billion in 2010 from $614.8 billion last year and second only to $723.7 billion in 2008.
Record Low Yields
Yields on two- and five-year Treasuries dropped to all-time lows last week, while the yield on the benchmark 2.625 percent note due in August 2020 fell to 2.39 percent in its fourth consecutive weekly decline, from 2.80 percent on Sept. 10. The price rose last week 1 1/32, or $10.31 per $1,000 face value, to 102, according to BGCantor Market Data.
Ten-year notes yielded 2.37 percent today as of 1:23 p.m. in Tokyo.
Demand from international investors for Treasuries clashes with the view of Warren Buffett, the chairman of Omaha, Nebraska-based Berkshire Hathaway Inc. Investors buying bonds now “are making a mistake,” he said Oct. 5 at Fortune magazine’s Most Powerful Women conference in Washington.
“It’s quite clear that stocks are cheaper than bonds,” Buffett said. “I can’t imagine anyone having bonds in their portfolio when they can own equities.”
Stock dividends are paying more than government bonds. Ten- year Treasuries yield 5.2 percentage points less than equities of companies in the Standard & Poor’s 500 Index when adjusted for annual inflation, near the most since March 2009.
Safety and Liquidity
Investors are seeking the safety and liquidity of U.S. debt as the global economy slows and as governments intervene in foreign-exchange markets to weaken their currencies by purchasing dollars.
Holdings of Treasuries in custody at the Fed for accounts including foreign central banks climbed 9.1 percent in the third quarter to $2.48 trillion, the biggest rise since a 16.6 percent increase in the last three months of 2008, after the bankruptcy of Lehman Brothers Holdings Inc. caused investors to abandon all but the safest government debt.
World economic growth will slow to 4.2 percent next year, from 4.8 percent in 2010, the Washington-based International Monetary Fund said in a report Oct. 6. Japan, to keep its exporters more competitive, said it sold more than 2 trillion yen ($24 billion) last month in its first sales in the foreign- exchange market in six years.
Demand from Japan and other foreign investors has eased concern about Obama’s ability to fund the deficit heading into the Nov. 2 congressional elections, even as his other initiatives have met resistance, such as his plan to keep tax cuts passed in 2001 and 2003 in place for households earning less than $250,000 while ending them for those who earn more.
Treasuries are attractive for Japan now because buying in dollars means selling yen, which rose yesterday to a 15-year high of 81.39 to the dollar. Much of the dollars purchased by the Bank of Japan in October likely ended up invested in Treasuries, according to Richard Franulovich, senior currency strategist at Westpac Banking Corp. in New York.
“I’m watching the markets carefully,” Japanese Finance Minister Yoshihiko Noda told reporters Oct. 8 in Washington, where he was attending a meeting of finance ministers from the Group of Seven. “There is no change in my stance that we will take bold actions, including intervention, if necessary.”
Japan’s total foreign reserves increased in September by $39.4 billion of which “foreign securities” accounted for $37.9 billion, according to Tohru Sasaki, head of Japan rates and foreign-exchange research in Tokyo at JPMorgan Chase & Co.
“This means that all the U.S. dollars obtained by intervention on Sept. 15 have already been invested in U.S. securities,” he wrote via e-mail.
While China’s Treasury holdings have declined by 10 percent from a peak of $939.9 billion in July 2009, there has been no drop-off in trade between the world’s two largest economies. U.S. exports to China increased 36 percent to $48.6 billion through July, while imports from China rose 22 percent to $193.9 billion, Commerce Department data show.
Sales of Treasuries are likely to be limited because any drop in bond prices or further weakness in the dollar would diminish the value of its remaining holdings.
Attempts by the People’s Bank of China to diversify away from the dollar will create a self-reinforcing decline in the currency, causing the central bank to “suffer enormous losses,” said Michael Cheah, who oversees $2 billion in bonds at SunAmerica Asset Management in Jersey City, New Jersey.
“The Chinese have to be very, very careful,” said Cheah, who worked at the Singapore Monetary Authority from 1982 through 1999, and now teaches finance classes at New York University and at Chinese universities.
For investors in Japan coping with record low yields, U.S. debt is relatively cheap. Ten-year Treasuries yield 1.52 percentage points more than similar-maturity Japanese government bonds, up from 0.82 percentage point in December 2008. Satoshi Okumoto, a general manager in Tokyo at Fukoku Mutual Life Insurance Co., said he bought Treasuries last quarter.
“Treasuries are quite attractive, especially from the view of Japanese investors, because there still is a yield,” said Okumoto, whose firm has the equivalent of $66.4 billion in assets. “Money is flowing into U.S. bonds from Japan.”
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