US Treasuries Go Buyer Direct

The US Federal Reserve released minutes of its June 19-20 monetary policy meeting overnight. The market was not impressed. Apparently, there are no signs of QE (money printing) on the horizon.

This makes sense if you think, as we do, that the Fed’s underlying motive is to monetise the government’s massive deficits whenever there is a funding shortfall. Right now, there is no shortfall. We’ll come back to that in a moment.

The far more interesting — and related — piece of news overnight was the action in the US Treasury market. $21 billion worth of 10-year Treasury notes were auctioned at a near record low yield of 1.45%. Normally, ‘primary dealers’ (the big Wall Street banks) conduct these auctions and distribute the bulk of the government bonds. Put another way, these banks collect money off their clients and give it to the government. In return their clients receive a paper promise from the government.

But last night’s auction was notable for the large proportion of ‘direct’ purchases. Over 40% of the auction came from ‘direct bids’, which refers to anonymous bidding…and bypassing of the primary dealers. According to the Financial Times, the recent average for direct bids at auctions is around the 17% mark.

It is usually foreign central banks who have the size to bid directly and anonymously. Who could it be? China is the usual suspect, but we’re not sure China is desperate for more Treasuries right now. What about Europe’s central banks? Could they be buying on behalf of their impaired domestic banks?

We don’t know of course. But the strong demand and ultra-low yields suggests someone is desperate for US Treasuries. Which brings us back to the Fed’s decision. The rest of the world seems to be financing the US government’s $1 trillion plus deficit with ease at the moment. There is no need for the Fed to step in with yields at these low levels.

Because US Treasuries are ‘risk-free’ and represent the world’s best collateral, in times of turmoil capital flows into the coffers of the US government. Just think about it. The US government absorbs more than US$1 trillion in global capital annually. It has been doing so since 2008 and will do so for many more years to come.

What does it do with that capital? Does it generate a decent rate of return? As far as we can tell it uses the funds to prop the economy up and stop it from crashing. The US economy rests on a foundation of around US$54 trillion of credit (debt). If the credit growth stops or even contracts by a minimal amount, the US economy and equity market fall into a hole. That’s why the Feds keep spending and that’s why the Fed Reserve is on standby to print what the government can’t get via the global capital markets.

The long-term implications of this insanity are mind-boggling. But no one’s mind seems to be boggling just yet. It’s all about short term preservation. After all, in the long run we are all dead. Anyone who knows how the financial system works knows that the US will eventually blow up, just like Europe…and Japan.


Greg Canavan
for Markets and Money

From the Archives…

How to Survive Inside China’s Financial System
06-07-2012 – Greg Canavan

China’s Economic Policy of Denial
05-07-2012 – Greg Canavan

The Question China Has To Answer Fast to Save Its Economy
04-07-2012 – Callum Newman

How Investing in Commodities Can Prevent a Personal Financial Crisis
03-07-2012 – Dan Denning

Wouldn’t it Be Nice to Not Lose Money on the Australian Share Market?
02-07-2012 – Dan Denning

Greg Canavan
Greg Canavan is a contributing Editor of Markets and Money and is the foremost authority for retail investors on value investing in Australia. He is a former head of Australasian Research for an Australian asset-management group and has been a regular guest on CNBC, Sky Business’s The Perrett Report and Lateline Business. Greg is also the editor of Crisis & Opportunity, an investment publication designed to help investors profit from companies and stocks that are undervalued on the market. To follow Greg's financial world view more closely you can subscribe to Markets and Money for free here. If you’re already a Markets and Money subscriber, then we recommend you also join him on Google+. It's where he shares investment research, commentary and ideas that he can't always fit into his regular Markets and Money emails. For more on Greg go here.

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There is no demand for US treasuries. Just looking at last year, the Fed purchased 60% of US Tresuries and that’s just what we know about. The late wise Bob Chapman suggested that the Fed actually purchased 85-90% of treasuries with the remaining 15-20% be bought from the primary dealers like JPMorgan. They wish to create the illusion of a safe haven but everybody knows that the US is as broke as any of the European countries. Actually even more so. So might I venture to say that our anonymous buyer here is the Fed itself
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