The Fed may not yet have made up its mind on another round of easing, but China and other foreign investors were already positioning for it late last year.
Chinese investors, including its central bank, were the top seller of Treasury securities at the end of last year, unloading $32 billion worth. But they were buying so-called agency bonds, which strategists say include mortgage securities.
Whether it’s a reach for yield or a bet on the Fed , or both, is unclear.
"China flows in December suggest that they had a "spread trade" in place as they sold $33 billion in L/T UST assets to buy $9.5 billion Agency bonds," writes George Goncalves, Nomura Americas Treasury strategist. "The Chinese have always viewed QE2 as an aggressive act by the Fed, seems like this time around they are positioning to profit from QE3 when it comes."
The Fed has been suggesting for several months that it could do another round of quantitative easing , or QE3, if it needs to. It has also made no secret that it would target mortgage securities to help drive rates lower and help the housing market.
So, the Treasury’s international capital flow data, released Wednesday morning, was of special interest when it showed a pickup in buying of Agency bonds.
The minutes from the Fed's last meeting, released Wednesday afternoon, show the Fed has not made up its mind about more easing but several members appear to favor it.
The Chinese purchases in December surpass their normal level, strategists note.
“I think it’s reasonably fair to say that at least on the margin, there’s some QE3 anticipation built into that decision,” said Ian Lyngen, senior Treasury strategist at CRT Capital.
In a note, Goncalves says the Treasury data showed a “complete lack of long-term UST buying interest” with the actual selling of $16.7 billion by foreign investors in both private and official accounts. Corporate bond selling, at $20.7 billion, was also one of the highest levels in months, he noted.
“…the only real buying of US fixed income assets were primarily in Agency bonds suggesting that overseas investors were setting up for an upcoming QE3 announcement,” he wrote.
The strong buying in Agency bonds was five times the year’s average. That, combined with purchases by U.S. domestic banks could explain why the mortgage backed securities markets has been seeing rich prices lately, he noted. Through January, mortgage spreads had narrowed against Treasurys.
He said the U.K. and Cayman flows, a proxy for hedge funds, were strong buyers of Agencies and sellers of Treasurys, according to the Treasury data.
"The market is positioned ahead of QE3 in all asset classes," said Goncalves, adding it could cause pain for some investors if it doesn't happen.
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