Overseas Capital Accelerates Withdrawal, U.S. Bonds Face Largest Selling Pressure in Six Years

Original Source: Wall Street News

The U.S. Treasury market is facing potential selling pressure from foreign official investors, a development that has raised high market alert.

According to the Wind Trading Desk, a research report released by Deutsche Bank on March 23 shows that the U.S. Treasury holdings in foreign official accounts custodied at the New York Fed plummeted by $75 billion over the past four weeks, marking the largest monthly decline since the COVID-19 shock in 2020. Based on historical data models, this change implies that foreign official investors actually net sold approximately $60 billion worth of U.S. Treasuries, also the largest since the pandemic.

This data corroborates the recent sharp rise in U.S. Treasury yields, particularly the abnormal upward movement in the mid-term (belly) yields—precisely the maturity segment where foreign official investors’ holdings are concentrated. Deutsche Bank warns that if foreign demand continues to shrink, the “convenience yield” advantage of U.S. Treasuries will face erosion, posing a substantive upside risk to long-term yields.

Custody Data Reveals Selling Signals

The most authoritative data source for tracking U.S. Treasury movements by foreign official investors is the U.S. Treasury Department’s TIC (Treasury International Capital) report. However, this data suffers from significant lags—the March data will not be available until mid-May at the earliest.

As an alternative indicator, the H.4.1 report released weekly by the New York Fed on Thursdays includes a memorandum item recording the face value of securities custodied at the Fed for foreign official and international accounts, with a lag of only one day. Deutsche Bank strategists Matthew Raskin, Steven Zeng, and Andrew Fu pointed out in the report that the latest H.4.1 data shows, on a weekly average basis, foreign official accounts’ custodied U.S. Treasury holdings have fallen by $75 billion over the past four weeks. This decline is not only the largest since March 2020 but also the second-largest single-cycle drop in nearly a decade.

Notably, unlike a similar situation in March 2023, the scale of FIMA repo operations did not rise simultaneously this time, indicating that this round of reduction constitutes direct sales or non-rollover at maturity, rather than liquidity financing through repo operations with the Federal Reserve. Foreign reverse repos, foreign official deposits, and FIMA securities lending have also shown little change over the past month.

High Correlation Between Custody Data and TIC Data

To what extent can custody holding data represent the overall changes in U.S. Treasury holdings by foreign official investors? Deutsche Bank conducted a systematic verification on this.

The report shows that over the past 15 years, the correlation between changes in custody holdings and foreign official net purchases in TIC data has been quite significant, with the former explaining about 50% of the variation in the latter. Even when shortening the sample period to post-2019 to exclude potential interference from changes in reserve management models, this relationship remains robust.

Based on this historical relationship, the $75 billion decline in custody holdings corresponds to a net selling scale by foreign officials of approximately $60 billion. Deutsche Bank notes this would be the largest net selling by foreign official accounts since the COVID-19 pandemic. To find a comparable case earlier, one would need to look back to December 2018.

Shift in Capital Flows Against the Backdrop of FX Intervention

This decline in U.S. Treasury custody holdings aligns closely with recent market dynamics observed by Deutsche Bank’s foreign exchange strategy team.

According to a previous report from Deutsche Bank’s FX strategy team, the U.S. dollar failed to strengthen as expected against the backdrop of the Iran war and surging oil prices, partly due to large-scale foreign exchange interventions by several Asian central banks. Concurrently, the team’s high-frequency ETF monitoring data also showed a significant slowdown in foreign investors’ purchases of U.S. dollar assets.

The convergence of these two clues points to a common conclusion: foreign official investors are reducing their allocation to U.S. dollar assets, with the selling of U.S. Treasuries being a direct manifestation of this trend.

Sustained Selling Could Push Long-Term Yields Up by Over 100 Basis Points

Deutsche Bank’s analysis reveals a structural concern: U.S. Treasury yields have long benefited from the “convenience yield” derived from the U.S. dollar’s reserve currency status, and this advantage is now being tested.

The report cites previous Deutsche Bank research indicating that the current 10-year U.S. Treasury yield is more than 100 basis points lower than the reasonable level implied by the U.S. Net International Investment Position (NIIP). Another recent academic working paper estimates that the U.S. dollar’s reserve currency status lowers U.S. long-term interest rates by about 90 basis points compared to a “normal level.”

Deutsche Bank warns that once foreign demand experiences a sustained decline, this convenience yield will face reversion pressure. U.S. Treasury term premiums and overall yields would have substantive room to rise, posing a direct impact on investors holding U.S. Treasuries.

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