Guess Who's Buying All the Bonds? (It's Not the Fed)

Mom-and-pop investors, and not the Federal Reserve, have been the ones most responsible for driving the mad dash to government debt, according to newly released data.

The Fed's ambitious Treasury-buying program has pushed the central bank's balance sheet to $2.83 trillion and, by many accounts, the benchmark 10-year Treasuryyield to record lows, most recently to 1.56 percent.

But despite the low yields, it's been retail investors most responsible for the recent move plunge.

"The conventional view is that 10-year Treasury yields have been pushed down to 1.5 percent and 10-year (Treasury Inflation Protected Securities) yields to -0.5% by the actions of the Federal Reserve and the safe haven demand from foreign investors," Capital Economics said in a research note. "The reality, however, is slightly different."

The demand among average investors has swelled so much, in fact, that they bought more Treasurys in the first quarter than foreigners and the Fed combined.

Households picked up about $170 billion in the low-yielding government debt during the quarter, while foreigners increased their holdings by $110 billion.

The Fed, meanwhile, actually slightly decreased its net holdings, not a surprise since its latest quantitative easing endeavor begun in September — nicknamed Operation Twist — was designed to be balance sheet-neutral. The central bank is selling short-dated notes and buying an equal number of longer-duration issues in an effort to drive down borrowing rates and boost risk.

For Capital, the more meaningful aspect of Treasury demand from households is that should the Fed opt not to do more easing when Twist concludes at the end of June, there still will be demand for that could keep yields from surging as some expect.

Retail investors have continued to draw down their money market funds but direct the cash instead to bonds, while equity mutual funds continue to lose flows. The move is seen in large part because of fears over the European debt crisis and U.S. economic slowdown.

Last week saw a mild reversal of the trend, with equity funds taking in about $1.5 billion and bonds losing $317 million, but the long-term story has been clearly on the side of fixed income.

"This suggests that even if the crisis in the euro-zone were to be solved overnight, any easing in demand for Treasuries from overseas investors may at least be partly offset by a further increase in demand from households," Capital's economists said. "With banks still looking to increase their holdings of risk-free assets and the Fed standing ready to launch a QE3 if conditions deteriorate, that may limit just how far Treasury yields can rise."