What are the best alternatives to US assets?

There Is No Alternative (TINA); so said former UK Prime Minister Margret Thatcher in the 1980s when describing the need for fiscal rectitude. But we can think of TINA in other contexts. Take US financial assets like bonds and stocks. It has long been said that there is no alternative to US assets for global investors given US attractions such as market scale and liquidity. It has also been said that if large holders of US assets, such as China, were to sell their US assets, it would risk market carnage. But what we appear to have seen in recent years is that there is an alternative to US assets and that hefty sales of treasuries by China have not collapsed the treasury market.

In order to see this, we need to separate out foreign official holdings of treasuries from those held by the foreign private sector. The former has stagnated; the latter has continued to climb. Many foreign central banks appear to have adjusted their behavior towards treasuries in some ways. The first is that a number appear to have taken a political decision to scale down their treasury holdings given the direction US policymaking has taken. The clearest example is Russia’s disinvestment, as it has been frozen out. Other BRICS countries have seen similar reactions, such as India.

As for China, it has been scaling back treasury holdings from the peak back in 2013, according to US Treasury International Capital (TICs) data, which covers both private and official Chinese holdings of treasuries. These now stand at USD 689 bn, or around half of the peak level seen back in 2013. That’s a pretty substantial disinvestment, and the bulk of it has been seen in the past few years, since the pandemic.

In addition to this apparently political decision to scale back treasury holdings, it seems that central banks have found an alternative asset: gold. Of course, gold has always been an asset that’s available to central banks, but it has traditionally been one that has received limited attention. That’s changed now, as gold is the most widely held reserve asset behind the US dollar.

But in spite of this significant disinvestment in treasuries by many central banks, we have not seen the collapse in treasury prices that many seemed to be warning about some years ago should China pull back. That’s probably down to many factors, including Fed treasury purchases as part of quantitative easing since the global financial crisis. But, specifically amongst foreign holders of treasuries, we’ve seen overseas private investors more than willing to take up the slack created by departing central banks.

However, Steven Barrow, Head of Standard Bank G10 Strategy said there would be two points about this as well. The first is that much of the demand for treasuries is not of the buy-and-hold type that we might see from central banks. In other words, it is more flighty, and that can produce bouts of pressure in the market. A second point is that the challenge to the treasury market from other bond markets seems to be slowly increasing. In some cases, this is down to yield, with Japan’s JGB market, for instance, now generating juicier yields for foreign and local buyers. In other cases, it is market depth, and here we are referring to the growth of shared debt in the eurozone. The region has made slow and steady progress on this front, particularly in the post-Covid period with the EUR750bn Next GenerationEU stimulus plan.

More recently, joint debt issuance has been selected to fund a defense buildup across the EU, and rather than use frozen Russian assets to fund a loan to Ukraine, the EU has decided to issue joint debt for the EUR 90 bn loan. In addition, bond future contracts have been created to add another string to the common debt bow. Now clearly, all this still leaves the eurozone very far behind the treasury market.

“Progress is going to be so incremental as to appear almost glacial. But the direction of travel is clear. Most likely private foreign demand for treasuries will continue to offset central bank diversification for some while yet. Hence, we are not suggesting some sort of imminent collapse in overseas demand or in treasury prices. But the writing is on the wall when it comes to the long haul, and that’s a scary thought when the US can’t seem to get its fiscal house in order,” said Steven Barrow.