Foreign purchases of U.S. debt rise

NEW YORK (CNNMoney.com) -- Foreign purchases of U.S. debt increased in the first month of 2009, according to a Treasury report released Monday, easing some concerns that overseas investors have lost their appetite for U.S. debt.

According to the Treasury International Capital (TIC) report released Monday, net foreign purchases of long-term Treasurys were $10.7 billion in January, down from a $15 billion rise in December. Still, the report relieved many investors' worries about the recently volatile TIC data, which showed foreign investors had sold a net $25.8 billion of Treasurys in November.

China continued to lead all foreign nations, buying up an additional $12.2 billion of Treasurys in January. Japan, the second largest U.S. debt holder, bought up another $8.8 billion of U.S. government bonds.

The Treasury has issued record amounts of debt to finance its expensive economic rescue efforts. But some investors have expressed concern that the huge increase in spending will drive inflation up and the value of their bond holdings lower.

Most notably, Chinese Premier Wen Jiabao said Friday he is concerned that the mammoth amounts of Treasury debt his country holds will deteriorate in value as the U.S. deficit increases. China owns nearly $740 billion of U.S. debt, more than 6% of the $10.9 trillion of U.S. debt outstanding, according to the TIC report.

"The Chinese are concerned about an unorderly unwinding of Treasury positions if the financial markets begin to recover," said Bill Larkin, portfolio manager at Cabot Money Management. "There are some signs that financial institutions may be better off than the market has been pricing in."

If stocks begin to recover, investors may look to sell off low-yielding government bonds in favor of stocks that have the potential for higher rewards. But as bond prices fall and yields rise, the value of Treasury holdings would fall.

Larkin said that an increase in yield to 4% from the current 3% level for the benchmark 10-year Treasury -- a realistic scenario -- would result in a 10% loss in value for the bond.

Still, the markets are so intermingled that foreign governments may simply be unable politically to unwind their U.S. holdings without facing repercussions from the United States.

"It has become a co-dependent system, so there may not be another option for [foreign holders of U.S. debt]," Larkin added.

On Saturday, President Obama said that the continued rise of foreign investments in U.S. Treasurys and other investments showed that government debt remains secure.

"I think that there's a reason why even in the midst of this economic crisis you've seen actual increases in investment flows here into the United States," Obama said. "I think it's a recognition that the stability not only of our economic system, but also our political system, is extraordinary."

The report, however, showed that foreign investors once again shunned U.S. agency bonds, which help mortgage finance giants Fannie Mae (FNM, Fortune 500) and Freddie Mac (FRE, Fortune 500) fund their purchases of U.S. mortgages. Foreign investors sold off a net $22.4 billion of agency debt in January, down from a $37.5 billion selloff in December.

Experts say foreign support has waned in recent months as the number of outstanding mortgages and amount of debt for sale fell.

"Foreign private investments have tapered off, but central banks' interest is holding its own - though it's certainly not growing," said Jim Vogel, head of agency debt research at FTN Financial.

Both companies have been forced to draw on the credit lines to fund continued mortgage purchases and guarantee activity. Freddie had already drawn down $14 billion of its credit line and last week asked the government for $30.8 billion in additional funding after posting a $23.9 billion loss in the fourth quarter.

Fannie Mae said last month it would draw down $15 billion of its own credit line after the company posted a $59 billion loss for 2008.

Still, some foreign interest in Fannie and Freddie bonds has helped the companies buy up home loans. Last week, Fannie successfully auctioned off $9 billion of agency debt. Though the vast amount of buyers were domestic investors, there was a decent amount of participation from Asian investors, according to Vogel.