Bud Conrad, a professor at California’s Golden Gate University and an avid investigator of the underlying causes of trends in the U.S. economy and financial markets, provided the following chart and commentary about one of the most important economic factors looming over the U.S. economy: foreign buying of Treasury bills. Below, Bud offers an explanation of this important indicator. From here on out, he’ll be updating us weekly on foreign Treasuries purchases, keeping a finger on the pulse of the U.S. economy.
The U.S. government relies heavily on foreigners to purchase its debt and keep the economy running smoothly. By buying U.S. Treasury bills, foreign central banks have in the past kept dollar values high and interest rates low. For example, The Bank of Japan (BOJ) became a large buyer at the end of 2003 and early 2004, when the weakening dollar threatened to make Japanese export goods too expensive for the critical U.S. market. To remain competitive, the BOJ bought Treasuries in an attempt to keep the dollar high and Japanese exports growing. The result of this and similar interventions by other central banks was that between 70% and 90% of U.S. government Treasuries issued at the time were purchased by foreigners.
Clearly, the level of foreign investment in U.S. Treasuries was the driving force that kept U.S. long-term interest rates low, even as many pundits predicted they would rise along with Fed tightening, potentially triggering an economic slowdown. Increased buying takes pressure off long-term rates, supporting continued borrowing for real estate, durables and business expansion. The economic engine thus keeps thundering on. But a drop in the level of Treasuries purchases by foreign banks could quickly change this by forcing rates higher.
How can you track Treasuries purchases? There is a little known weekly indicator you can use to monitor international investments by central bankers. It is related to a service the Federal Reserve offers in which it acts much like a broker for the foreign central banks. It works like this: Let’s say the BOJ wants to buy some Treasuries, they ask the Fed to do the transaction for them and to hold the Treasuries in a “Custody Account”. Every week the Fed reports how much is in the two custody categories of Treasuries and Agencies held on behalf of all foreign institutions. The weekly reports are produced in the report H.4.1 found at the Federal Reserve Web site under statistics, at: www.federalreserve.gov/releases.
Looking at the historical data, we monitor the annualized rate of purchases as a simplistic form of early warning system to give us some indication of what may be ahead for long-term interest rates and, by extension, the U.S. economy. Keeping a close watch on the details of this report over the coming months can give us a good understanding about the way the U.S. economy, and the dollar, are heading.
For the time period covered above, I conclude that foreign central banks are not buying new Treasuries. The last time the drop was this large was in 2003. Foreign central banks account for over two-thirds of total foreign purchases in the latest month of November, so they are an important sample of the overall purchases. It may be that the non-custody holders are making up for the Central banks slowing, but the data isn’t available to show that yet. My parallel lines emphasize to me that the general trend of these purchases is now down, a change from what we’ve previously seen.