NEW YORK, Aug 26 (Reuters) - Weak demand at back-to-back U.S. Treasury auctions this week has bond mavens wondering if China and other emerging market central banks are spending their foreign exchange reserves at home to offset investor flight during market turbulence rather than buying U.S. debt.
Treasury prices have fallen sharply in the past two days after poor auction results for 2-year and 5-year notes, and data from the sales suggest a notable drop in the category of bidding traditionally seen as a gauge of foreign official demand.
The selling pressure was pronounced enough to prompt prominent bond market players to wonder if these long-time buyers, China in particular, were suddenly on strike.
“China selling long Treasuries ????” Bill Gross, the widely followed bond fund manager at Janus Capital, said in a Tweet during Wednesday’s sell off.
That would be a troubling development because Treasuries have long been a favorite asset of foreign central banks, which buy them in part to offset the flow of foreign investment into their economies. For the United States, sturdy overseas demand for its debt helps finance the federal government’s deficit spending and holds down borrowing costs.
But now, fears of capital outflows accelerating from emerging economies mean these countries cannot simply sit on their piles of IOUs from Uncle Sam, analysts said.
“If capital were to leave emerging economies, especially those that peg their currencies against the dollar, the natural thing to do is to sell Treasuries,” said Gene Tannuzzo, portfolio manager at Columbia Threadneedle Investments in Minneapolis.
China stunned investors when it devalued the yuan earlier this month, while emerging market currencies such as the Malaysian ringgit, Indonesian rupiah and Brazilian real have declined to decade-plus lows against the dollar.
On Tuesday, China cut interest rates and required bank reserves in a bid to stabilize its stock market and to restore confidence in its economy. On Wednesday, Thailand, Southeast Asia’s second biggest economy, said it would speed up domestic investments on 17 projects worth $47 billion.
Treasury auctions on Tuesday and Wednesday featured worrisome signs that foreign central banks were not the big buyers they had been up to now. Foreign central banks typically purchase new Treasuries through bond dealers who bid on their behalf, a category of buyers identified as “indirect bidders.”
On Wednesday, indirect bidders bought 50.06 percent of $35 billion of new 5-year notes, their smallest share since last October. The day before, they took down just 47.09 percent of $26 billion in 2-year notes, the smallest share since May.
These are still sizable purchases, implying any abating appetite is likely modest, if not temporary, analysts said. The latest data from June shows China owned $1.27 trillion of Treasuries to rank as the top foreign holder, up from $1.24 trillion at the end of 2014.
And the pullback from indirect bidders, which also include fund managers, may stem in part from jitters about whether the Federal Reserve will try to raise interest rates by year-end, analysts said.
Still, some parts of the U.S. bond market point to active sellers in recent days as the plunge in Chinese stock prices unnerved global investors, analysts said.
One sign is how expensive the newest 10-year Treasury notes have become relative to older issues, said David Keeble, global head of interest strategy at Credit Agricole Corporate & Investment Bank in New York.
The latest 10-year paper, issued in early August, has not been this pricey compared with older issues in two years or more, he said. That could be a sign that some foreign central banks are dumping their Treasuries onto bond dealers.
“They may be loading up dealers with them,” Keeble said. (Reporting by Richard Leong; Editing by Toni Reinhold)