US Treasuries - the whole new world

[foglifter]

It just happened that lately I read a couple of bonds-related articles that somehow hit me as an evidence of how much the bond market has changed for the last few years thanks to the Fed policies. 

1. Not sure if this was posted here, but I incidentally learned that after the 2008 crisis Barclays created US Aggregate Float Adjusted Index as an alternative to US Aggregate Index.
http://www.reuters.com/article/2009/07/ ... MW20090730

"... a new benchmark of the dollar denominated investment grade bond market that excludes Treasuries, agencies and MBS held in Federal Reserve accounts. 
... The underlying constituents of the US Aggregate Float Adjusted Index will be the same as those of the US
Aggregate Index, but net purchases and sales by the Federal Reserve will be excluded from the float adjusted index on a monthly basis, thereby reducing the market value weight of these securities. "

What happens next is Vanguard moves all it's bond index funds to this new index - a move, that surely had been much more actively discussed by Bogleheads. We all know that Vanguard Total Bond fund is one of their portfolio "staples".
http://www.advisorone.com/2009/09/23/va ... benchmarks

Lastly, Jason Zweig wrote an excellent article in his latest Saturday column: Are Bond Rates on a Road to Nowhere?

"Historically, the bulk of U.S. Treasury debt was held by private investors—including the big institutions that used their enormous market power, vigilante-style, to keep interest rates in line.

Now,... much of the demand for U.S. debt comes from "uneconomic" buyers who scoop it up—and hold on to it—at any price. Only 23% of Treasurys are held by individual and institutional investors—down from 55% in 1982 and 31% a decade ago. Today, foreign holders—largely central banks desperate to stabilize their currencies and banking systems—own 34% of Treasury debt. That is up from 13% in 1982 and 18% a decade ago. The Federal Reserve, meanwhile, holds 11% of Treasurys, twice its share in 2008."

The very first comment to the article, by Robert Stewart, elaborates on those 23% held by private investors:

The 23% held by investors is an interesting value in itself. According to today's article by Steve Schaefer of Forbes, three quarters of the 23% (18%) is “Mom and Pop”? investors, up from 5% in 2007. If this is true, then the institutional holdings of Treasuries have fallen from 31% in 2002 to just 5% now.

Now, back to Jason Zweig's article. He points out another remarkable source of "price-insensitive demand" for bonds:

But the market might not be fully recognizing another looming problem, Mr. Petzel says. Under the Dodd-Frank financial-overhaul law, the trading of many derivatives ... will eventually migrate to central "clearinghouses." Buyers and sellers will have to post "margin" or collateral, to back their positions. One obvious choice for that margin would be U.S. Treasurys—yet another form of the artificial demand for government debt that the economist Carmen Reinhart calls "financial repression."

Such derivatives total an estimated $700 trillion in "notional" or face value outstanding. If only 10% of the total is affected, with an initial requirement of even just 1% margin from both the buyers and the sellers, that implies an extra $1.4 trillion in demand for short-term Treasurys, reckons Mr. Petzel. Those new purchasers would have to buy the debt no matter how paltry its yield.
...
with so many new holders who aren't price-sensitive, Treasurys are more likely than ever to hold up in a crisis—as they did in 2008 and 2009. Thus, even at today's measly yields, Treasurys still have a place as a hedge against a fall in your stock portfolio."

It seems to me that Treasuries are evolving into some sort of a "hard asset". Or should I say "government gold"? Treasurys market is rigged, which definitely influences the whole bond market. Well, knowing your bonds will rock in the next crisis surely sounds nice, but what happens to Treasurys in less dramatic scenarios is still a grey area. In terms of PP the question is whether this "evolution" changes the Treasurys as an asset class to such an extent that the classic 4x25% formula may no longer do what it is supposed to do. I'm not talking about radical steps, like replacing LTTs with another asset (which one, gold?). But it would be interesting to contemplate possible changes to, say, re-balancing rules or is 25% still the right number.

I'd love to hear what our bond experts think. Perhaps I haven't even asked the right (or the best) questions, so if you see other interesting discussion points resulting from these articles please chip in.

[craigr]

I continue to maintain that the bond market is even harder to predict than the stock market (which is just about impossible)! So while all of these things are possible, it's also possible that if the stock market turns around people will leave treasuries so fast that these kinds of stories will look very quaint!