U.S. households soaking up Treasury debt flood

By Emily Kaiser - Analysis

WASHINGTON (Reuters) - Americans have developed an appetite for U.S. 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 behavior.

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 U.S. debt, American households are quickly catching up.

With $605.9 billion in Treasuries as of June 30 -- up from $240 billion six months earlier -- U.S. 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 U.S. bonds or are lured by bigger returns elsewhere once economic confidence returns.

"What we worry about in the U.S. Treasury market is, who is the next buyer after foreign central banks?" Drew Matus, U.S. economist with BofA Merrill Lynch Global Research, said in an interview. "If it's only the domestic U.S. 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 U.S. 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.

GLOBAL REBALANCING

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. (here)