Crisis Pushed Foreign Investors Toward Treasurys

By MAYA JACKSON RANDALL and MIN ZENG A global flight to safety sent foreign investors scrambling for short-term dollar-denominated assets in October, with buyers from around the world snapping up some $147 billion in Treasury bills as the credit crisis hit a peak. With global markets roiled by the fallout from the Lehman Brothers bankruptcy and the bailout of insurance giant American International Group Inc., foreign buyers shunned longer-dated securities including stocks and corporate debt, purchasing just $1.5 billion after buying $65.4 billion in September, according to monthly data published by the Treasury Department. Monday Markets: Fed As Backstop 3:00 The Federal Reserve must create an incentive for the private sector to participate in the markets, says Axel Merk of Merk Investments. MarketWatch's Stacey Delo reports. (Dec. 15) "Net long-term capital flows to the U.S. declined sharply in October, as the global financial crisis reached a zenith and risk aversion became acute," said Brian Bethune, chief U.S. financial economist at IHS Global Insight. "Sharp business-cycle downturns in Europe, Japan and emerging markets precipitated sharp drops in commodity prices and a severe global flight to quality," he added. That trend likely continued in November and December, as hefty demand for T-bills drove annual yields on the three-month bill into negative territory last week. Monday, the three-month bill yield stood at 0.02% as investors continued to opt for safety over returns. Amid the turmoil, foreigners fled debt issued by the federally chartered housing finance firms such as Fannie Mae and Freddie Mac, which the government had nationalized in the previous month. Foreign investors sold a net $50.2 billion in such debt in October, compared with purchases of $6.2 billion in September. What's more, this trend continued in November and December, noted Tony Crescenzi, interest rate strategist at Miller Tabak & Co., citing data from the Federal Reserve. UPI/Landov Lehman Brothers' collapse spurred a flight to Treasurys. "It is critical that foreign investors stay invested in U.S. securities, in particular in light of the massive U.S. effort to end the financial crisis and given the size of the U.S. budget deficit," Mr. Crescenzi wrote in a note. Foreigners have continued to move out of so-called agency debt even after the Fed in late November launched a plan to buy as much as $100 billion of this debt. The Fed's actions have however helped the agency market recover, Mr.Crescenzi noted. In total, net capital inflows to the U.S. soared to $286.3 billion in October from September's $142.6 billion. Among foreign holders of Treasurys, China remained in the lead, after overtaking Japan in September as biggest holder of U.S. government debt. Its holdings jumped to $652.9 billion in October from $587 billion in September. Japan's October holdings totaled $585.5 billion. "China has apparently been swapping its agencies for Treasurys, as evidenced by its massive net purchase of $65.9 billion of Treasurys in October," Mr. Crescenzi said. Foreign demand for Treasurys has remained strong even as the government has sold massive amounts of new debt to fund its support programs for the economy. Monday, Treasurys continued to rally as investors mulled the prospects of the Fed using unconventional tools -- such as buying longer-dated Treasury debt -- to keep cash flowing to the economy as official lending rates fall toward zero. Investors expect the central bank to cut its key lending rate, currently at 1%, by as much as 0.75 percentage point Tuesday at the end of its two-day meeting. "The bond market is setting up for the possibility of a profound shift in stance by the Fed that could include the buying of Treasurys," said Eric Lascelles, chief economics and rates strategist at TD Securities in Toronto. The benchmark 10-year note ended up 16/32 point, or $5 for every $1,000 invested, to yield 2.535%. That is down from 2.590% as bond yields fall when prices rise. Indications of a broad drop in prices in a regional manufacturing report also added fuel to Treasurys' gains. Write to Maya Jackson Randall at Maya.Jackson-Randall@dowjones.com and Min Zeng at min.zeng@dowjones.com