As in, build it and they will come … where ‘IT’ is a cheaper/steeper concession given what is widely anticipated to be increased FRONT-END issuance. Watch / listen for talk of 20yr and NOTE lack of conversation of more ULTRA LONG issuance.
It is with THAT in mind, I thought I’d pass along, revisit some thoughts from Natixis on 24th April asking WHO will buy increased supply. Their conclusion: cheaper/steeper will help and MOM & POPS will buy.
While that seems very mainstream, consensus (and so, out of character for me to pass along) how about we use it as a place-marker and point of reference with some ‘meat on the bone’ as far as all the hype and talk.
24 April 2018
INVESTMENT STRATEGY REPORT
WHO WILL BUY THE INCREASED SUPPLY OF US TREASURIES?
Many factors have had an impact on demand for US Treasuries over the last few years, leading to significant changes in the holding structure of US government debt. In this paper we will look at these changes which, in the case of resident investors, are characteristic of captive demand and raises the question of where demand for UST will come from as the Fed gradually exits its QE programme (balance sheet normalisation) and once the regulatory adjustments have been made.
Over the last few years, demand for UST has noticeably exceeded the financing requirements (deficit); this has been an unprecedented situation of “excess demand”. The coming quarters will, on the contrary, be characterised by a sharp increase in the supply of UST, in line with the increase in the fiscal deficit.
What will be investors’ capacity to purchase/absorb these volumes? In order to assess their behaviour, we analyse some investors’ sensitivity to various factors (expected 3-month interest rate, expected 10-year interest rate, expected inflation and nominal GDP, dollar’s effective exchange rate, oil prices). For the period in question (1990-2017), the results show weak correlations between these factors and the behaviour of domestic investors as a whole and separately, with two exceptions (households and mutual funds).
Non-residents seem to be more sensitive to these factors, and an estimation suggests that the presence of non-residents will be reduced in the coming quarters. Domestic investors will therefore have to absorb the supply shock resulting from the increase in the deficit and the normalisation of the Fed’s balance sheet, and households in particular. This has already happened during previous phases of increasing fiscal deficits (late 1970s and early 1990s), which went hand-in-hand with more or less marked rises in US long-term interest rates.
…From excess demand to excess supply: what factors for what demand?
…Beyond these short-term movements, the extent of the rise in interest rates will notably depend on how demand reacts to the increase in the deficit, which is resulting in a change of regime. While demand for UST has been noticeably greater than the financing requirements (deficit) in the last few years, an unprecedented situation of “excess demand” in terms of both amount and length, the coming quarters will, on the contrary, be characterised by a sharp increase in the supply of UST.
NOW, as bearis as it all might appear, I’d have to say the ultimate conclusion doesn’t seem TOO terribly bearish … here are the remaining few sentences and a visual from the very end of the note …
…The model does not seem to be very robust statistically, but it shows a positive and significant coefficient of the oil price factor and opposite coefficients of the interest rate factors (positive for 10-year interest rate forecasts and negative for 3-month interest rate forecasts), reflecting the importance of the yield curve slope factor (cost of dollar vs yield on long-term UST). The results suggest that the presence of non-residents will be reduced over the coming quarters.
The different results presented above suggest that domestic investors will have to absorb the supply shock linked to the increase in the deficit and the normalisation of the Fed’s balance sheet, and households in particular.
It seems that they will be able to absorb this shock. Their share of the holding of UST is low relative to the average observed since 1990, and even more so since 1980 (8.7% versus 11.8% and 13.3%). This has already happened during previous phases of increasing fiscal deficits (late 1970s and early 1990s), which went hand-in-hand with more or less marked rise in long-term interest rates (450bp and 60bp).
Call or write if you’d like more from this Natixis report and good luck today with ADP, Refunding and this afternoons almost forgotten FOMC statement.