from Follow the Money

Good thing that there are plenty of Agencies left …

May 30, 2007

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Monetary Policy

Since it sure seems that there aren't many 3 to 10 year Treasuries still floating around for central banks to buy.  Central banks have already bought up most of the stock!

The US clearly has -- thanks to the government sponsored Agencies -- a comparative advantage turning mortgages into something that can be sold to foreign central banks.  The increase in central bank Agency holdings so far this year has been breathtaking.  Look at the Fed's custodial data.  There is a lot of money that has to go somewhere.

I personally was pleased by the Bloomberg story for another reason: it confirmed something that Elisa Parisi-Capone and I argued last year, namely that central bank demand isn't limited to the short-end of the Treasury curve.   When the details of the 2006 survey come out, we will have to update our analysis.

The fact that central banks aren't just buying Treasuries -- in part because the US isn't, in a sense, issuing enough to meet demand, in part because central banks want a bit more yield -- does make it somewhat harder though to estimate how central bank demand is influencing the US interest rates.  Warnock and Warnock used to adjust for custodial bias by looking at total foreign demand for Treasuries, as they argued a lot of bonds were buying bought through London custodians and other intermediaries for central banks.   They were right, but that adjustment alone won't work now that foreign custodians are buying a lot of Agencies and other bonds for official investors.   Looking at all foreign purchases of bonds -- and then trying to estimate the share coming from central banks -- presumably would still work.   

I don't think central banks are behind every move in the Treasury market.  But I do think that they are one big reason why Treasury yields have consistently been below what most models would predict.

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