Impact of the Fed taper: The Treasury International Capital report (Part 2 of 8)
The Treasury International Capital report was one of the most important releases last week for U.S. debt markets. Issued on Tuesday, February 18, by the U.S. Treasury Department, the release reported on cross-border portfolio investment flows and positions between U.S. and foreign residents for the month of December 2013.
The TIC reported a net outflow in net foreign acquisitions of long-term and short-term securities and banking flows of $119.6 billion in December. This was a sharp fall from November’s net outflow of $16.6 billion. A net outflow implies that U.S. investors and institutions purchased more securities abroad than their foreign counterparts’ purchases of U.S. securities. An inflow would have implied the opposite.
China, Japan trim Treasury holdings
China and Japan, the two largest foreign U.S. creditors, reduced their positions in the Treasuries. China reduced its holdings of Treasury debt by 3.6% or $47.8 billion from November’s position and Japan by $3.9 billion. Net foreign holdings of the U.S. Treasuries, however, increased to a record $5.8 trillion in December, an increase of about $78 billion over November. This was mainly due to increases in Treasury holdings by Belgium (up $56.2 billion) and Hong Kong (up $17.1 billion).
Key takeaways from the Treasury International Capital release
Although the impact of Fed’s tapering program (which commenced December 18) is visible in some areas of the report, the effect is not apparent on the net foreign demand for longer-term U.S. Treasuries. This is because net inflows have actually increased compared to November, primarily on account of flight-to-safety flows from emerging markets. However, net inflows for agency-backed securities have been declining since August 2013. The interest rate on a 30-year, fixed-rate, conventional home mortgage has increased about 1% since April 2013 to 4.43% in January 2014.
What is significant here is the reduction in Treasury portfolio holdings by China and Japan. Tapering is expected to reduce the demand for U.S. Treasuries and agency-backed securities as the Fed gradually ceases its monthly bond buying program (currently at $65 billion per month) implying lower bond prices in the future. If countries like China and Japan with large exposure to Treasuries begin to offload their positions, this will put more pressure on prices and result in higher yields or costlier debt.
Although the report has its limitations, does not capture all the data below certain threshold limits, and has institutional constraints amongst others, it does give bond investors an estimate for the demand for U.S. debt securities abroad.
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