Who owns Treasury, agency, MBS and credit

Steven Abrahams | September 27, 2024

This document is intended for institutional investors and is not subject to all of the independence and disclosure standards applicable to debt research reports prepared for retail investors. This material does not constitute research.

Ownership of Treasury, agency debt and MBS and corporate and structured credit highlights some important structural differences across those markets. The Treasury and agency markets still have big exposure to shifts in monetary policy and bank regulation while credit markets sit solidly in private hands. And across all markets, foreign portfolios play dominant roles. Trade and foreign policy turns out to be more than just politics.

Ownership structure affects all asset markets, including the $60.3 trillion market in US debt securities. Things that create change in the appetite or ability of big owners to hold positions affect valuation and liquidity. But those things differ in significant ways across major sectors of the US market.

The Treasury market

The Treasury market depends on the foreign bid by orders of magnitude more than any other. Investors outside the US held 33% of outstanding marketable Treasury value at the end of the second quarter, twice the share of the second largest holder and three times the third largest holder (Exhibit 1). Foreign holdings also rose 1.1% in the second quarter, outstripping the 0.1% rise in overall Treasury value. And unlike the early 2000s when foreign central banks led the bid, the vast majority of growth in the last few years has come from private investors such as banks, insurers, mutual and hedge funds and so on. In the second quarter, private holdings rose 1.9%, for example, while central bank positions rose 0.33%. The shift from policy to private portfolios has likely made the aggregate foreign bid much more sensitive to yield and relative value. Treasury debt consequently competes for these buyers against highly rated US corporate and structured credit.

Exhibit 1: Share of marketable Treasury debt (and quarterly growth) as of 2Q24

Source: Federal Reserve, Santander US Capital Markets

The Fed comes next with the second largest portfolio of marketable Treasury debt, holding 16% of the total. The Fed portfolio share started sliding with the end of QE in late 2021 and dropped in the second quarter this year by another 4.4%. The rate of decline may slow with the end of QT, when the Fed plans to reinvest maturating Treasury debt and reinvest MBS principal into Treasury debt. But Fed share will likely continue shrinking after QT as outstanding Treasury debt continues to grow.  This diminishes the role of a portfolio more concerned about the policy value of Treasury debt than the investment value.

Next come households at 11%, a category in the Fed’s world that includes hedge funds and nonprofits and that often serves as a plug for balances not accounted for elsewhere. It is hard to know what to make of the trajectory of household holdings, which grew 3.9% in the second quarter.

The rest of the Treasury market sits in a range of different types of smaller portfolios unlikely to have significant marginal impact on yields absent extraordinary growth or liquidation. Money funds hold nearly 10% of outstandings, but almost all of it in T-bills and unlikely to affect yields along the rest of the curve.

Although the foreign share of the Treasury market has held around 33% to 34% since early 2020, the shares for the Fed and households have traded places and varied significantly (Exhibit 2). Fed share peaked at the end of 2021 at 26.4% before falling, and household share bottomed at the same time at 2.2% before rising. The opposite directions for share reflect use of the household category as a catchall. Nevertheless, the variability of the Fed share highlights the market’s exposure to shifts in policy.

Exhibit 2: A stable foreign share of Treasury debt since 2020

Source: Federal Reserve, Santander US Capital Markets

The agency debt and MBS market

While foreign portfolios headline the Treasury market, banks take the spotlight in agency debt and MBS, holding nearly 25% of the market. The Fed’s numbers do not separate the $2 trillion in federal agency debt at the end of the second quarter from the $9 trillion in guaranteed MBS. Banks tend to hold callable agency debt and MBS pass-throughs and CMOs, which are good sources of yield spread over Treasury debt, low risk weighting and good liquidity. Agency debt and the MBS guaranteed by Fannie Mae and Freddie Mac, for example, get a favorable 20% risk weighting and qualify as Tier II high-quality liquid assets for liquidity requirements. The MBS issued by Ginnie Mae get a 0% risk weighting and qualify as Tier I. Bank share of this market has stabilized in 2024 after falling since the end of 2021, and bank portfolios grew 0.1% in the second quarter, lagging the 0.6% growth in the market.

Exhibit 3: Share of agency debt, MBS (and quarterly growth) as of 2Q24

Source: Federal Reserve, Santander US Capital Markets

As in the Treasury market, the Fed comes next holding nearly 18% of the combined market, although 99.9% of Fed exposure is in MBS rather than debt. Fed share has dropped from a peak of more than 24% at the end of 2021, and dropped 3.3% in just the second quarter. The Fed plans to keep letting MBS run off even after QT ends, and the pace of runoff could accelerate as interest rates fall and encourage housi1ng turnover and refinancing in loans backing the Fed’s MBS. Falling Fed share broadly means debt and MBS transfer from a policy to private portfolios, which will likely require wider spreads to hold the asset.

Households currently play the next largest role, with nearly 13% of this market. This share has moved up since late 2021 and increased by 10% in the second quarter alone. However, the role of this category as a catchall again makes the gains hard to interpret.

Foreign portfolios also play an important role in the agency debt and MBS markets, currently holding near 12% of the total  market although dropping by 2% in the second quarter. Anecdotally, buying of MBS by foreign private portfolios—banks and insurers especially—has picked up in the last year or two. The likely growing role of private foreign portfolios has made this bid much less sensitive to trade imbalances and foreign exchange policy.

As for other portfolios, perhaps a surprisingly small share is held by investors managing entirely for total return. In particular, mutual funds hold around 6% of the total. Other portfolios such as state and local governments, life insurers, credit unions and private pensions also weight asset-liability matching in the investment decision along with regulatory capital and other considerations.

Surprisingly, the foreign bid for agency debt and MBS has proven the most stable over the last five years. Foreign share has run between 11% and 12% steadily for the last five years while Fed and bank share have varied and traded places with household share. Agency debt and MBS consequently remain sensitive to Fed policy and bank appetite, which can shift based on changing asset-liability needs and regulatory risk and liquidity policy.

Exhibit 4: Foreign demand has proven most reliable in agency debt, MBS

Source: Federal Reserve, Santander US Capital Markets

The corporate and structured credit markets

In contrast to the leading roles played by the Fed or banks or both in the Treasury and agency markets, they play a minor part if any in corporate and structured credit. Here, foreign portfolios play the lead part, holding more than 29% of the total and growing by 0.1% in the second quarter (Exhibit 5). Almost all of this is foreign private portfolios including banks, insurers, mutual and hedge funds that have US dollar funding from deposits, premiums, debt or repo.

Exhibit 5: Foreign portfolios, insurers and mutual funds lead in credit markets

Source: Federal Reserve, Santander US Capital Markets

Life insurers hold the second largest share with nearly 23%, growing 0.6% in the second quarter. Yield, convexity and duration long enough to match life insurance liabilities is the draw. Insurer accounting, which does not reflect mark-to-market in capital and allows amortization of gains and losses over long horizons, also allows insurers to hold relatively illiquid credit positions.

Mutual funds hold the third largest share at more than 15%, and, combined with the ETF share of more than 6%, tallies to 22% of total corporate and structured credit clearly owned by mark-to-market total return portfolios. ETFs also showed the fastest rate of growth in the second quarter. The proportion owned by total return is likely larger after considering that some foreign buyers are mutual funds and hedge funds.

The combined holdings of foreign, life insurer and mutual fund portfolios accounts for a steady 67% to 70% of all corporate and structured credit over the last five years (Exhibit 6). That puts the market solidly in the hands of private portfolios sensitive to relative value and, compared to the Treasury and agency debt and MBS markets, less sensitive to either monetary policy or shifts in bank regulatory pressures.

Exhibit 6: Foreign, life and mutual funds account for a steady majority of credit

Source: Federal Reserve, Santander US Capital Markets

Across fixed income markets

The structure of ownership across these major markets highlights both different sensitivities to monetary policy and bank regulation and a consistently important role for foreign buyers.

The Treasury and agency debt and MBS markets have major exposure to banks and the Fed, the two combined holding 42% of the agency debt and MBS market and 22% of the Treasury market. In those markets, monetary and bank policy matters as much as relative value and other goals of private portfolios. Corporate and structured credit have minor exposure to those policy risks and depend almost entirely on private incentives.

In every market, foreign portfolios matter. They dominate the Treasury and credit markets and hold the fourth largest share of the agency debt and MBS market. The incentives of foreign buyers obviously vary in big ways across central bank and private portfolios, but foreign appetite clearly matters for spreads and liquidity across US fixed income. US growth and interest rates relative to domestic markets and foreign trade, among other things, affect both foreign portfolio appetite and ability. Given potential change on those fronts in the months and years ahead, those will be things to watch as they affect the foreign bid for important parts of US debt.

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The view in rates

Neutral on rates for now, given the aggressive path already priced in for Fed easing. As of Friday, fed funds futures priced in another 78 bp of easing this year and nearly 200 bp through 2025, implying fed funds at the end of next year around 2.84%. As fed funds head toward the neighborhood of 3%, the front end of the yield curve should drop to reflect the lower policy rate with the 10-year and longer end of the curve moving much more slowly if at all. Opportunities to outperform the broad market have shifted from rate positioning to spread positioning.

Other key market levels:

• Fed RRP balances closed Friday at $437 billion, up $152 billion in the last two weeks. Since the Fed dropped policy rates by 50 bp on September 18 and set the RRP rate at 4.80%, balances have jumped as T-bill yields have dropped well below RRP yields.
• Setting on 3-month term SOFR closed Friday at 459 bp, down 10 bp on the week.
• Further out the curve, the 2-year note closed Friday at 3.56%, down 3 bp in the last week. The 10-year note closed at 3.75%, down 1 bp in the last week.
• The Treasury yield curve closed Friday afternoon with 2s10s at 19 bp, steeper by 4 bp in the last week. The 5s30s closed Friday at 60 bp, steeper by 1 bp over the same period
• Breakeven 10-year inflation traded Friday at 216 bp, up 1 bp in the last week. The 10-year real rate finished the week at 159 bp, unchanged over the last week.

The view in spreads

Implied rate volatility dropped after the September 18 FOMC meeting, a common outcome, and has held steady since. That is a marginal plus for spreads in risk assets. The Bloomberg US investment grade corporate bond index OAS closed Friday at 90 bp, tighter by 1 bp on the week. Nominal par 30-year MBS spreads to the blend of 5- and 10-year Treasury yields traded Friday at 125 bp, wider by 3 bp in the last week. Par 30-year MBS TOAS closed Friday at 31 bp, unchanged over the last week.

The view in credit

Fundamentals for consumer and corporate credit still look relatively robust. The prospect of lower interest rates should slowly relieve pressure on the most leveraged corporate balance sheets and office properties. Most investment grade corporate and most consumer sheets have fixed-rate funding so falling rates have limited immediate effect. Rising unemployment should put pressure on consumers, but high levels of home equity and investment appreciation should buffer the stress. Other parts of the market funded with floating debt continue to show weakness. Leveraged and middle market balance sheets are vulnerable, although leveraged loan defaults and distressed exchanges have plateaued in recent months. US banks nevertheless have a benign view of credit in syndicated loans. Commercial office real estate looks weak along with its mortgage debt. Credit backing public securities is showing more stress than comparable credit on bank balance sheets. As for the consumer, subprime auto borrowers and younger households borrowing on credit cards, among others, are starting to show some cracks with delinquencies rising quickly.