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Wednesday, August 12, 2009

It Seems That the Chinese Know How to Buy Treasury Bonds

Since the beginning of the financial crisis there has been much written about how the Chinese concerned about the creditworthiness of the US and the consequences of large deficits leading to inflation, higher interest rates and a consequent decline in the value of any bonds they buy now.

Well it seems the Chinese are cocnerned about possible inflation and its impact on their treasury bond holdings and not very concerned about default risk on US treasury bonds. As a consequence they are increasing their holdings of TIPS (treasury inflation protected securities) as protection against inflation and the higher interest rates that usually accompany inflation. In fact,the US Treasury increased its offering of TIPS in response to indications from the Chinese of their interest. Individual investors would be well advised to follow China's example. As I have written for a long time,TIPS (owned through an etf or very low cost mutual fund) should be a core holding in every portfolio.

Below from the WSJ with my bolds (btw given their past behavior it's a pretty safe bet that Pimco (whose manager is quoted in the article) has been buying TIPS. Given that they are the world's largest fixed income manager not a bad sign for the TIPS market.

TIPS Sales Boost Confidence in U.S., Pimco Manager Says Article Comments (1) more in Markets Main »Email Printer

NEW YORK -- The Treasury Department's plan to expand inflation-linked bond sales will bolster the confidence of Chinese officials to continue to underwrite U.S. government debt supply, said Mihir Worah, a senior fund manager at bond fund giant Pacific Investment Management Co.

That's important because China, with more than $800 billion in Treasury holdings, is the largest foreign holder of U.S. debt. Policy makers there have been concerned that these holdings, most of which are held in nominal, or cash, Treasurys, will drop sharply in value if U.S. efforts to support the domestic economy through massive government spending lead to a spike in inflation....

... the greater issuance of TIPS strengthens the U.S.'s commitment to reining in the large fiscal deficit. That's because higher inflation translates into higher costs to the government in the form of payments on its TIPS debt.

"One of the implicit benefits from the TIPS program is that it gives the Treasury the credibility that they would not inflate away debt," Mr. Worah told Dow Jones Newswires. "China wants to make sure the nominal Treasurys they own won't lose value due to hyperinflation."

Benefits of TIPS
The move to expand TIPS sales gives "China the confidence to maintain or continue to buy nominal Treasurys," said Mr. Worah. "That is one implicit benefit of the TIPS program -- overall lower funding cost for nominal bonds and the government."

In its August refunding announcement last week, the Treasury Department said it is "committed to issuing TIPS in a regular and predictable manner" in all maturities, adding that market participants can expect issuance to gradually increase in the fiscal year that starts in October 2010.

The U.S. pledged to China during the bilateral Strategic and Economic Dialogue last month that it is committed to TIPS issuance and is studying ways to boost inflation-protected debt sales. Right now, the U.S. government sells five-year, 10-year and 20-year TIPS.

Mr. Worah, who manages Pimco's flagship $13.2-billion Real Return Fund, said the Treasury is likely to release more details on expanding the TIPS program as part of the November refunding announcement.

He expects the Treasury to increase the amount of TIPS supply by $10 billion to $20 billion, mostly in the five-year and 10-year TIPS, in the coming fiscal year...

So far, individual investors and pension funds remain the biggest players in the TIPS market, Mr. Worah said, but he noted growing flows from foreign investors like banks and sovereign wealth funds this year.

If central banks were to join the TIPS investor community, they would be an important market participant, noted one member of the Treasury Borrowing Advisory Committee in the minutes for the August refunding.

This year through Monday, TIPS have handed investors a gain of 5.79%, while nominal Treasurys have lost 4.86% over the same period, according to data from Barclays.

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