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The other major buyers in the recent past – Japan and China – have also largely disappeared,with their shares of the US bond market at record lows. Where,in 2007,they owned more than a quarter of all US government securities on issues,between them they now own less than 8 per cent.
Japan still owns just over $US1 trillion of US bonds,but its holdings have been shrinking partly because the bond market rout means the bonds are worth significantly less,but also because Japanese bond yields have been edging up and hedging costs have risen,and therefore Japanese investors have begun buying their own government’s bonds.
China,with about $US835 billion of bonds according to the latest available data,has been cutting its holdings of US bonds,although it still appears to be an investor in some US debt – but in agency rather than government debt. The heightened tensions between the US and China could be a factor in its decision-making.
The conundrum for any foreign investor,sovereign or otherwise,considering buying into what is still regarded as the world’s safe haven in volatile times – and these are volatile times,as the weekend’s awful events in Israel demonstrated – is that the prospect of even higher rates and yields in the US market means they would be risking good money after bad.
The combination of increasing yields and the stronger dollar exacerbates the scale of potential losses for a foreign investor.
Unless and until US interest rates plateau and market yields start to fall in anticipation of lower rates,the US market is a dangerous place for investors,but particularly foreign investors.
That means that most of the buying of the deluge of US Treasuries in prospect will have to be done by US investors,with the narrower base of support suggesting that,regardless of what the Fed does,US interest rates are likely to be higher than they would otherwise have been in order to match the supply with demand.
It is,of course,possible that the Fed tightens too much and leaves rates higher for longer than it should and pushes the US into recession. That wouldn’t help the supply-demand equation but it would lessen the bleeding in terms of the bonds’ values.
It is also conceivable that foreign investors ignore the risks of losing money in the US market and flood in again because of an even greater risk of losses elsewhere. We saw at the onset of the pandemic that investors were prepared to accept negative yields in exchange for security.
There’s always been the potential for something globally destabilising to flow from the war in Ukraine,and now there’s a very nasty and threatening flare-up in the always-volatile Middle East.
The Hamas assault on Israel has added a new strain of uncertainty,volatility and risk to the already volatile and risk-laden global financial environment. Oil and gold prices shot up over the weekend and the US dollar strengthened further after the attack.
If aWall Street Journal report that Iran helped plan the attack were proven,the potential for a wider conflict,one which could have repercussions well beyond the Middle East,would increase.
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For markets,even the prospect that Israel might retaliate would have a big impact on oil prices and,through them,economies and financial markets. Any broadening of the existing conflict could,of course,have consequences far more unsettling and distressing than the impact on the price of gasoline,or shares or bonds.
When the Fed started winding back a balance sheet swollen by its responses to the 2008 financial crisis and subsequently the pandemic,it ended one of the biggest bull markets for bonds in modern history,and the most unconventional era of central bank monetary policy in history.
A decade and a half of ultra-low interest rates and generally loose monetary policy is being displaced by pre-GFC interest rates and tightening monetary policies,and not just in the US. And,at least in the bond market – so far – the bubble era gains that central bankers gifted investors via their unconventional policies are being vaporised.
While it is conceivable that the Fed and its peers might have to come to the rescue of investors again if something of systemic threat develops,the inexorable trajectory of deficits and debt in the world’s most influential market means it is unlikely that we’ll see settings again that are anywhere near as artificial,or as favourable for bond and equity investors,as those central banks created in the post-financial crisis period.
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