November 2, 2018 / 7:43 PM / 9 months ago

U.S. debt auctions face demand risk from rising hedging costs

* U.S. to sell $83 bln in bonds for November refunding

* Cross-currency swap rates hit year’s highs before retreat

* China, Japan have been cutting back on Treasuries holdings

By Richard Leong

NEW YORK, Nov 2 (Reuters) - The U.S. government’s debt sales to raise $29 billion of fresh cash next week face uncertainty about foreign demand as the cost to hedge dollar-denominated assets recently hit a 2018 high for European and Japanese investors.

The U.S. Treasury Department said on Wednesday it will sell a total of $83 billion of fixed-rate securities including record amounts of 10-year and 30-year debt next week as a part of its quarterly refunding.

The jump in hedging costs for European and Japanese buyers may suppress overseas purchases of Treasury supply at a time when U.S. government borrowing has surged in the wake the massive tax cut enacted last December and a spending deal reached in February.

Diminishing overseas demand for Treasuries will likely put more upward pressure on borrowing costs not only for the U.S. government but for consumers and corporations, analysts said.

Reduced Treasuries demand will also likely send the dollar lower.

Higher hedging cost “may weigh on Treauries demand. That may lead to higher yields or a lower dollar,” said Peter Wilson, international fixed income strategist at Wells Fargo Investment Institute in London.


The costs for European and Japanese investors to protect their dollar exposure climbed to their highest levels of the year in October following the Federal Reserve’s interest rate increase the month before.

In the currency market, the cost premium on three-month cross-currency swap contracts, measured by the three-month dollar LIBOR over the three-month rate on euros, was quoted about minus 42 basis points late Friday. It retreated from minus 54.5 basis points earlier this week, ICAP data showed.

The premium for players to exchange yen-denominated payments for dollar-pegged payments was quoted at minus 50 basis points, pulling back from 63.75 basis points more than two weeks ago.

Banks and hedge funds use these swaps for currency bets, while overseas insurers and pension funds use them to hedge their dollar denominated bonds. A smaller swap rate translates into a higher cost for hedging a cross-currency investment.


China and Japan, the two biggest U.S. foreign creditors, have scaled back their Treasuries holdings this year, another risk factor for the auction.

China, which is a trade row with the Trump Administration, reduced its Treasuries ownership to $1.165 trillion in August, while Japan’s holdings fell to $1.029 trillion, a level not seen since October 2011.

On the other hand, private foreign demand for Treasuries was resilient this summer. U.S. money managers have also stepped up their Treasury purchases.

“Generally the trend is lower demand,” said Subadra Rajappa, head of U.S. rates strategy at SG Corporate & Investment Banking in New York. “Investors will want more concession” at the upcoming auctions.

On Friday, the yield on benchmark 10-year Treasury notes rose to 3.21 percent, a two-week high, following an upbeat October payrolls report. The 10-year yield was within striking distance of 3.26 percent reached on Oct. 9.

Reporting by Richard Leong; Editing by Daniel Bases and Tom Brown

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