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Treasury Bond ETFs Shouldn’t Count on Support from Foreign Investors

This article was originally published on ETFTrends.com.

Treasury bonds and related exchange traded funds have enjoyed a long rally as low interest rates abroad brought foreign buyers into relatively more attractive U.S. government debt. However, international interest for Treasuries is waning.

While rising interest rates may be a primary driver to the 3.6% decline in the iShares 7-10 Year Treasury Bond ETF (IEF) and 8.7% drop in the iShares 20+ Year Treasury Bond ETF (TLT) year-to-date, the diminished demand from foreign investors may further weaken the Treasury bond outlook.

Overseas investors, traders and central bankers only increased their holdings of Treasuries by $78 billion in the first eight months of 2018, or over half of what they bought during the same period last year, the Wall Street Journal reports.

Furthermore, foreign demand only accounts for a much smaller share of Treasury issuance as the government increased supply at auctions to fill a growing budget gap. International buyers now make up 41% of outstanding Treasury debt, the lowest level in 15 years, compared to 50% as recently as 2013, according to U.S. Treasury data.

The sudden drop off in foreign demand has fueled a bond selloff this fall, which pushed yields on benchmark 10-year Treasury notes to a recent 3.15%, and continuing cutback in international appetite could further cause trouble for the financial markets.

“Yields are rising to reflect a risk premium, rather than healthy growth,“ Mark McCormick, North American head of foreign exchange strategy at TD Securities, told the WSJ. “People are concerned about how reliable a store of value the dollar is right now.”

U.S. budget deficit concerns

Specifically, observers are concerned about the U.S. budget deficit, which is at its widest level in six years after the tax cuts and other fiscal-stimulus measures enacted under the Trump administration. Moody’s Investors Service projects the budget gap to expand to 8% of gross domestic product by 2028, compared to less than 4% now.

Related: Slow and Steady Muni Bond ETFs Are Taking the Lead

Furthermore, some central banks, sovereign-wealth funds and global investors may be reducing their U.S. dollar exposure as they diversify holdings, while others may have deemed their USD reserves sufficient to pass through any further risk of economic troubles.

For example, Goldman Sachs calculated that Russia’s central bank could may have dumped as much as $85 billion in dollar-denominated assets, including Treasuries, which may have been attributed to concerns over U.S. sanctions.

For more information on the fixed-income market, visit our bond ETFs category.

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