Fed became second-largest Treasury investor in Q1

The Federal Reserve overtook household investors as the second-largest holder of Treasuries in the first quarter, after foreigners, as the US central bank purchased bonds as part of its second round of quantitative easing, Fed data released on Thursday showed.

The Fed's USD 600 billion bond purchase program has displaced a number of traditional Treasury buyers as the central bank sought to stimulate the economy and drive investment into alternative asset classes.

There has been fierce debate over whether other investors will step in to replace the Fed when its ends the bond purchase program at the end of this month.

PIMCO's Bill Gross has been the most vocal Treasury bears, warning that Treasury yields will jump, while others, including BlackRock's Rick Rieder and DoubleLine Capital's Jeffrey Gundlach, see the impact on bonds as likely priced in.

Fed data shows that households, previously the second-largest Treasury investor group, stepped out heavily in the first quarter, the first full quarter of the Fed buying program that began in late November.

The households category, which includes some hedge funds, posted a net outflow of USD 155 billion to total USD 959.4 billion, its lowest holding since the first quarter of 2010.

The Fed, by contrast, increased Treasury holdings to a record USD 1.340 trillion. They have risen from USD 776.6 billion in the first quarter of 2010.

Foreigners, by far the largest Treasury investor class, holding almost half of outstanding US government debt, continued to buy in the first quarter, though at a much slower pace than previous quarters.

They increased holdings to a record USD 4.445 trillion, up USD 67.6 billion on the prior quarter.

Outstanding Treasury debt also rose to a record USD 9.621 trillion, from USD 9.362 trillion in the fourth quarter of 2010.

WILL BUYERS COME BACK?

Buyers returned in force after the end of the Fed's first QE program, when both foreigners and households made record quarterly Treasury purchases, and investors hope they will return again.

One potentially positive sign is that households have continued to show a preference for fixed income and cash, which may be serving as a substitute for Treasury bonds.

Households put a net USD 86.5 billion into money market funds, the first quarterly inflow since the first quarter of 2009, and also increased check deposits. Households also invested USD 225.7 billion in other mutual funds.

Foreigners also dramatically increased lending between banks, with net interbank assets increasing by USD 255 billion in the quarter, compared with USD 17.25 billion in the prior quarter, which was the first positive quarter since the third quarter of 2009.