US investors could put more than $470 billion to work in US treasuries if Asia’s appetite for dollars continues to fall. According to analysts at CreditSights, US banks, mutual funds, insurance companies, and money market funds are all significantly underweight treasuries relative to historical levels.
“The US money market mutual funds were the most shocking,” said senior analyst Christian Stracke at CreditSights’ recent London conference. “They are barely invested.” According to their latest annual or semi-annual reports, of the five largest US money market funds by assets, three – the Merrill Lynch CMA fund, Smith Barney’s Cash Portfolio fund, and the Vanguard MMR Prime Portfolio – held no US treasuries at all. Just 0.4% of the Fidelity Cash Reserves fund was invested in treasuries. The figure for the Schwab Money Market Fund was 1.3%.
If US commercial banks and life insurers returned to their 1996 exposure to US treasuries, if larger retail fixed-income funds moved to market weight, and if the top 20 money market funds all had a 20% allocation to treasuries, that would amount to $469 billion of demand. And that’s without assessing the impact of similar moves from pension funds, non-life insurers, investment banks and brokers.
“US investors have ample power to fill the gap in Asian purchases,” says Stracke.
The question is, will they? Asia is financing much less of the US fiscal deficit this year. In July, Asian purchases of US treasuries were less than 15% of the total net increase in US public debt. At the end of 2004, the figure was close to 60%.
But this has had little impact on the US yield curve. Repositioning by US investors, which were crowded out of the market in 2003 and 2004, could be the reason.
And in the near term, repositioning will make sense. A reduced appetite for dollars in Asia is driven by smaller current account surpluses in the region. These reflect higher consumer demand in Asia, which is inflationary for the global economy. That in turn could result in higher-than-expected interest rate increases from the Federal Reserve, which would push US treasury rates higher, meaning US investors would not have to keep looking elsewhere for yield. More general concerns about commodity prices and credit could drive investors away from risk and back into safer assets.
“It’s hard to say explicitly whether domestic accounts are bridging the gap,” says Vasan Varathan, head of investor coverage in the interest rate group at BNP Paribas in North America. “But they are playing a bigger role in the long end, where you see large pension funds looking at an indirect ALM play.”