The dependence of US long- term interest rates on the actions of foreign central banks was highlighted this week when reports about the management of Russian and Chinese foreign exchange reserves shook the bond market.
News on Tuesday that Russia's central bank was planning to increase the proportion of euro-denominated assets in its reserves fuelled a slide in the dollar and raised concerns that Treasury purchases by foreign monetary authorities would dwindle.
Another reminder of the vulnerability of Treasury yields to overseas policy shifts came yesterday. The market was caught off guard by a report in China Business News, the Shanghai newspaper, that the country's central bank had cut its Treasury holdings to limit losses from a falling dollar.
Although officials later denied the veracity of the report, a seed of doubt was planted.
A bond strategist said: "A cynic would suspect the timing of the allegedly erroneous report was not a coincidence. It came at the quietest time of the year. This has been a reminder to the Americans of the influence that China wields over the Treasuries market."
The US government bond market has this year defied many bearish forecasts, thanks largely to relentless Treasury purchases by Asian central banks.
Last year, foreign central banks bought $441bn of Treasuries, helping finance 83 per cent of the US current account deficit. While the Chinese central bank has slowed its purchases of US government bonds in recent months, the Bank of Japan has continued to mop up new issuance.
However, on Friday Reuters quoted a senior official at the Japanese ministry of finance as saying the BoJ had largely completed the Treasury purchases prompted by its currency market interventions, which ran until March. "Unless there is more currency intervention, there should not be a big change in the current picture," the official said.
The dollar's recent slide against the yen may increase the pressure on the BoJ to undertake further intervention. But buying assets denominated in a falling currency becomes an increasingly costly tool of exchange rate management.
"Reserve purchases …expose a central bank to foreign exchange risk," the Federal Reserve Bank of New York said in a recent publication. "If the domestic currency eventually appreciates against the dollar …the central bank's foreign assets lose value in domestic currency terms."
Two-year German Schatz yields were up 0.5bp at 2.32 per cent, while equivalent UK gilt yields added 1.4bp at 4.374 per cent.
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