first thing that likely comes to mind is the stock

market. But there's actually a bigger, less

flashy counterpart to the equity market: the bond

market. Probably the biggest market out there

when it comes to capital markets, you hear a lot

about the equity side, but in reality the bond

market is much, much bigger.

At the heart of it lies one of the safest assets

in the world, U.S.

Treasury bonds. As interest rates have risen

over the past few years, treasuries have offered

some of the highest yields in decades.

The US Treasury market is a large market in the U.S

. fixed income world, it's giving you higher yield

than it has in the last 20 years.

The yield levels and the income opportunity is is

much, much more interesting and attractive

today than 12, 18, 24 months ago.

We've been used to having incredibly low yields here

in the US and globally.

Buyers of US treasuries have been changing, and

the shift could have broad implications for the

US economy.

We've seen over the last couple of years is we've

seen a declining appetite for US government debt,

which is really unusual.

The US sort of stood out across all the other

countries as being so dependent on foreign

investors.

China's pulled back as a buyer, Japan has pulled

back as a buyer.

China and Japan have not over many, many years been

huge buyers. I feel like we have not paid attention

to the treasury market because it was a market

for foreigners or for the

Fed. Now it's a market for all of us and it's giving

you better yield. So it's something which we should

not ignore.

So why are major buyers fleeing the Treasury

market? What's the impact on yields and the economy

at large? And just how can investors best

navigate the market going forward?

So we have a really healthy overall bond

market in the US.

It comprises of US government bonds,

corporate bonds, mortgage bonds.

Treasuries is a key one, which is basically the

federal government issuing debt for their

funding needs.

Almost half the bond market is the US Treasury

market, according to the Bloomberg Aggregate Bond

Index, which tracks the performance of US

investment grade bonds and is widely considered

to represent the bond market as a whole.

Us treasuries account for over 42% of the index.

So I almost view the Treasury market as the

benchmark bond market, which is used for every

other corporate bond.

And sets the tone as sort of the risk free rate for

all the other investments in the bond market.

So those bonds are considered to be very,

very safe investments because they're guaranteed

by the US government.

If you're going to invest a dollar into Treasury

bonds, you're going to get that that dollar back.

While the Federal Reserve doesn't directly control

Treasury yield levels, their actions on

short-term borrowing rates or the Fed funds

rate can indirectly feed its way through the

market. That's another thing that we've seen

consistently over the past year and a half or so

that as the Fed has raised its benchmark

borrowing rates, say by a quarter point or half a

point, the Treasury market has generally

followed in kind. If the Fed's going higher, bond

holders generally say, okay, we want more yield

as well. US Treasury buyers can generally be

classified into one of two sub categories:

domestic and foreign.

On the one hand, you have your domestic buyers, of

which the Federal Reserve is one of the largest

buyers of treasuries.

Just a year ago, the Fed was a big buyer.

But the Fed steps in when they are doing QE,

quantitative easing, is where they step in as a

buyer. You have pensions, insurance companies, money

market funds, real money investors as well as banks

that buy treasuries.

And on the foreign side, we see pretty good demand

from a variety of countries for for

treasuries, both Japan as well as China are very

large holders of Treasury bonds.

Foreign investors are a big buyer base.

It's a much smaller buyer base today than it was

ten, 15 years ago, but it's still a solid source

of demand. Historically, perception has always been

that given the fact that treasuries are very

desired by both domestic as well as foreign

investors, that there's always demand for

treasuries. But that thesis was put to test

late last year, when we saw the surge in Treasury

supply because of of an increase in both bill as

well as coupon issuance.

In the last few years, so I'm talking about the last

couple of years, really since Covid, we've seen

foreign demand for treasuries declining

significantly. There's been a pretty major shift

in the buyer base of treasuries away from some

of the more traditional players, like the foreign

governments in general and even the Federal

Reserve themselves.

Demand from global central banks,

particularly Japan and China, are huge buyers of

US debt. They have pulled back, particularly China

has pulled back quite a bit.

Their holdings are now less than $1 trillion,

which is the first time that's happened in a

number of years.

Both Japan and China, while still ranked as the

top two foreign holders of US treasuries, have

seen their respective holdings decline in recent

years, right around the same time the Federal

Reserve began raising interest rates in March of

2022. For example, Japan has historically been a

very, very large buyer of the US treasuries.

They had a significant yield pickup by buying US

treasuries for a very long time, compared to

what they can find at home. That has been

eroding of late, because if I am a life insurance

company in Japan, my liabilities are in yen.

And so if even if I earn a lot of dollars on my

Treasury position, I need to hedge it back to yen

because my payment is made in yen.

Their cost of buying treasuries on a currency

adjusted basis has gone up quite meaningfully over

the last six months.

Two other big buyers that emerged in the last few

years was the Fed that was doing QE to try and be

stimulative to the economy. Well, QE is over.

We're actually undergoing quantitative tightening.

So the fed is not buying.

They're actually letting their portfolio shrink.

There's still very large holders of US treasuries,

but they're not as actively buying.

And the other one was banks. Domestic banks very

big buyers of treasuries since Covid because

deposits grew significantly and loan

demand wasn't high, well deposits have been

shrinking. The Treasury has had to rely on other

market participants to step in and take down that

additional supply.

And so now the new marginal buyer is really

US domestic investors.

And who's that: that's mutual funds, households,

pension, insurance.

And they've been kind of picking up the slack to a

certain extent as these, you know, foreign kind of

demand and buyers have been stepping away.

So when I think of the natural buyers of

treasuries, those that would buy treasuries, you

know, not necessarily because they expected it

to work in a portfolio sense, those buyers are

gone. As we're seeing a shift towards some of

these more domestic investors, be it, again,

hedge fund mutual funds, individual investors, uh,

what we're observing is that there are a lot more

price sensitive.

They're just not quite as as sticky.

So we would expect to see a little bit more

volatility here going forward.

That's why you look at the Treasury market.

Now we're moving even when the Fed's not doing

anything. The fed hasn't hiked rates or cut rates

um in the last six months.

And yet the ten year moves 7 to 8 basis points

on a daily basis.

And then also this other concept of what we call a

term premium, which means the extra yield that

investors want for holding longer-term

securities. Investors want to be compensated for

taking down that additional supply.

That's played a significant role in the

rise so far in Treasury yields, which now we've

seen the ten year yield actually eclipse 5% at one

point. Elevated Treasury yields, in particular the

ten year yield, can have a ripple effect on the

broader economy.

The ten year is considered a direct feed

through to certain parts of the market,

particularly mortgage rates.

As the ten year yield rises, mortgage rate

generally rises in tandem.

It sets the floor for interest rates and then

every other the mortgage rate is going to be higher

than that, and the corporate rate is going to

be higher. For instance, when the ten year yield

was close to 5%, mortgage rates were north of 8%.

So that's why we sort of call it the benchmark ten

year. Note that it is something that markets and

also lenders, banks, that kind of thing position a

lot of their other rates off.

You can see a scenario where the Fed's cut rates

to 3% and the ten year is still at 4%, because we

just don't have enough buyers off the ten year

within the US domestic space.

Similarly, high Treasury yields can also have an

impact on the stock market.

If, for example, the risk free rate or say, the ten

year yield from a from a Treasury perspective is

very, very high and you as an investor just feels

like all I need is a 5% return on my savings.

Well guess what? That's where you're probably

going to just put it into treasury yields.

Because again, if your risk free rate is this,

then the moment I start to take on risk, I should

get paid more. You want to make sure that you get

some return on top of that risk free rate.

I would say in general I am positive on bonds.

Fed is done.

It's a good hedge against risk assets and there's

likely to be money moving out of money market funds

and bank deposits into bonds.

Our view is that we should expect a little bit

more of a stable environment coming into

2024. The Federal Reserve, we think, is done

from their, you know, hiking cycle.

We don't expect them to hike rates anymore.

So we expect Treasury yields to decline

gradually during the course of this year, as

the expectation in the market is for the fed to

cut rates. And when the fed starts to cut rates

normally, that's the start of a bull market.

If the fed continues where some of the ending their

cut, as we call it, or the FX hedging costs

starts falling, and some of these foreign buyers

and the Federal Reserve's perhaps start stepping

back in at some point, then that could, you know,

absorb some of those price sensitive buyers

volatility. Yields look quite attractive.

Ten year yields are still slightly north of 4%.

We like to stress to investors that the yield

and therefore the income is the vast majority of

the returns for fixed income.

So at these high levels, you have a much better

opportunity. As for investors who may have

missed out on the 5% Treasury yield back in