Americans have developed an appetite for US government debt at a most opportune time - just when the Treasury has an awful lot of it to sell. Stunned by an $11 trillion drop in wealth, households more than doubled Treasury debt holdings in the first half of 2009 to protect battered savings, helping soak up a flood of government borrowing.
The coming months will test whether the surge in demand was simply a short-lived flight to quality in the midst of a panic, or a more lasting shift in investor attitudes and behaviour. Depending on the answer, the implications for the broader economy are big. Without a sufficient core of willing buyers, the cost of financing government debt would soar, putting a drag on an economy fighting its way out of a deep recession.
While foreign central banks in countries such as China and Japan remain the most critical source of financing for US debt, American households are quickly catching up. With $605.9 billion in Treasuries as of June 30 - up from $240 billion six months earlier - US households held more than the world's major oil exporters, Caribbean banking centers and Brazil combined. The only major foreign holders with larger positions were China and Japan.
The question is whether private investors remain loyal to US bonds or are lured by bigger returns elsewhere once economic confidence returns. "What we worry about in the US Treasury market is, who is the next buyer after foreign central banks?" Drew Matus, US economist with BofA Merrill Lynch Global Research, said in an interview. "If it's only the domestic US investor, what's the (interest) rate that they want to get paid on it?"
The renewed household demand is critical now because the government needs somewhere between $1.5 trillion to $2 trillion in funding to cover a gaping budget deficit this fiscal year.
And some other sources of demand are fading. The US Federal Reserve wraps up its $300 billion Treasury debt purchase program this week, and China has been dropping hints it wants to diversify its dollar-heavy $2.27 trillion reserve portfolio.
This week alone, the government is selling a record $123 billion in bonds. So far, the demand has been remarkably robust. How much of the recent debt issuance went to households will not be known for a while. The Federal Reserve's quarterly flow of funds report provides the most thorough assessment of households' balance sheets, but it takes several months to compile. Third-quarter figures are not due until December 10.
More timely data comes from the Investment Company Institute, which tracks the flow of new money into equity and bond mutual funds. Though it does not break out figures for Treasury debt, its latest report shows bond funds have seen either larger inflows or smaller outflows than equities in every month since the recession began in December 2007.
The jump in household Treasury holdings is a clear sign Americans are saving more, something the White House has promoted as a necessary part of making the global economy less susceptible to boom and bust cycles. At the start of the recession, the saving rate had dwindled to just 1.5 percent of income, according to Commerce Department data. By the second quarter of 2009, it had more than tripled to 4.9 percent.
President Barack Obama and his economic team want the United States to save more, and big export powerhouses such as China to spend more, to reduce big imbalances they think contributed to the latest financial crisis. Treasury Secretary Timothy Geithner said in a recent Reuters interview the rise in US saving meant the country was less reliant on the rest of the world to finance its budget deficit.
"And that puts us in a better position to manage through this," he said at the Reuters Washington Summit this month. Whether Treasuries will remain big beneficiaries of this thrift among US households is an open question. The strongest arguments in favour of government bonds are based primarily on demographics and emotions.
The baby boomer generation, born in the years after World War Two, is rapidly approaching retirement age and in theory would be keen to reduce risk. Younger investors may have been scarred by stock market volatility in the past decade, which ripped a large hole in 401(k) retirement plans.
A recent research paper from economists Ulrike Malmendier and Stefan Nagel found people who lived through rough economic times such as the Great Depression remained risk-averse even several decades later. But as confidence in the economy and financial markets is rebuilt, investors may again be tempted by fatter returns.
The yield on the benchmark 10-year Treasury note, which stood at 3.44 percent on Wednesday, looks lean measured against the reality of rising healthcare costs and longer life expectancy, Wells Fargo chief economist John Silva said. "The yields are pretty low," he said. "I'm in my 50s, so for someone like me, I know that getting 3.5 percent on my 10-year Treasuries is not going to pay the medical bills. It's just not going to happen."
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