Although foreign investors continue to be the largest purchasers of most types of US bonds, this sector showed less interest in Treasuries than in the past, shifting assets into short-term repurchase agreements in Q1 2006.

In same quarter, the offer of new bonds rose due to seasonal issues by the US Treasury and to domestic corporations resorting to record levels of bond issuance to finance stock buybacks.

With foreign investors moving out of Treasuries and with heavy new bond issues by the government and private corporations, bond prices fell.

Broader Support for Bond Markets

Higher interest rates and uncertainty about equity markets attracted increased flows to bonds from insurers, funds, banks, and households.

If the Federal Reserve continues to push short-term interest rates upwards and if foreign investors continue to move into short-term fixed investments, such as repurchase agreements, long-term interest rates may be forced higher.

However, considering the seasonal nature of Treasury issues in Q1 2006, the declining federal fiscal deficit, and the (perhaps) temporary nature of corporate borrowing to finance stock buybacks, it is not clear whether record levels of bond issuance will persist throughout 2006.

The following graph combines flow of funds tables for Treasuries, agency bonds, corporate bonds, and municipal bonds and shows bond issuance rising to high levels relative to demand.

	Demand for Bonds: US Market: Q1 2006

Net issuance of bonds into the U.S. market in Q1 2006 surpassed prior records, forcing bond prices to fall and rates to rise.

Total, annualized net sales for corporate and foreign bonds, agencies, treasuries and municipal bonds reached $2.2 trillion, 70% higher than bond issuance in 2005.

There are several reasons for this record level of bond issuance:

• Issuance of Treasury bonds, which seems to be seasonal, was running higher in the first quarter of the year;

• Issuance of agency bonds, which had fallen sharply after the accounting scandals at Fannie Mae in 2004, was now returning to normal levels;

• Bonds issued by domestic corporations were at record levels, primarily because of the desire to raise money to pay for stock repurchases.

	Net Issuance: US Bond Markets

The excess of US imports over exports continued to provide dollars to the rest of the world, which were invested in the US bond market.

The graph shows that foreign investments flowed into the market for US fixed income securities in Q1 2006, at a rate 25% greater than in 2005. (See Table F107, Rest of the World).

	Foreign Purchases of US Fixed Income Securities

Although foreign central banks reduced flows into US treasuries and agencies after the high point of 2004, the shortfall has been more than covered by flows into bonds from foreign private sources.

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