The mysterious August dollar rally; it wasn’t supported by any uptick in foreign demand for US assets
This morning’s TIC data release tell us two things:
One, the dollar can rally without any obvious supporting inflows. Net TIC flows in August (line 30) were essentially zero (-$0.4b). Foreigners (apparently led by official investors, but the data here is deceptive) were net sellers of US long-term assets, selling about $9b. Americans sold $23b of their foreign assets — providing the US with a bit of financing. But things like amortization payments on the outstanding stock of Agency bonds (line 20) cut into the inflow from the sale of US assets abroad. Net long-term flows were essentially zero. And so were net short-term flows.
Don’t ask me to explain how the US has sustained a $120b trade deficit in July and August on the back of a $34b net outflow of funds over those two months in the TIC data. Something doesn’t quite compute.
Two, the argument that official investors are a stabilizing presence in the market needs to be marked to market — or at least marked to the observed flow. And the observed flow suggests an enormous flight by official investors out of bonds with any hint of credit risk and into Treasuries. That hasn’t been stabilizing. It has added to the stress in the credit and inter-bank markets — and ultimately contributed to the broad financial environment that forced the Treasury to step in and guarantee the Agencies and now most bank debt.
The evidence here is overwhelming.
The TIC data release indicates that official institutions sold $13b of long-term Agencies, reduced their holdings of short-term Agencies by about $9b and sold another $2b of corporate bonds and equities while buying $5b of long-term Treasuries and $12b of short-term Treasuries.
That though likely understates the swing, as most “private” purchases of long-term Treasuries and Agencies have recently been from the official sector (see the pattern of revisions that followed the June 2007 survey — which found that official buyers accounted for nearly all foreign purchases of Treasuries and Agencies). Overall, foreign investors — including official investors — bought $35b of long-term Treasuries (and $55b of short-term Treasuries) while reducing their holdings of long-term Agencies by $30b and their total holdings of Agencies by close to $40b (the fall in short-term Agencies is on line 39 of this data release). Stabilizing that was not.
The country detail tells a similar story.
China bought $18.3b of long-term Treasuries and $4b of short-term Treasuries while reducing its holdings of long-term Agencies by $7.1b and its holdings of short-term Agencies by $3.3b. Think $22.3b to Treasuries (and another $5.7b into bank deposits) and at least $10b out of Agencies. China also sold “corporate bonds” in August. In the past it has been a significant buyer. Watch this going forward. I suspect (but don’t know) that Chinese state banks and SAFE may have significant holdings of the paper issued by large US financial institutions. China certainly has been buying some kind of US corporate debt recently — and given that the state banks have been running down their foreign portfolio investments, by best guess is that it has come from SAFE.
The “Asian oil exporters” (think the Gulf) acted similarly. They added $1.4b to their long-term Treasury holdings, while cutting their holdings of long-term Agencies by $3b. Above all though, they piled into cash — their total short-term claims increased by $11.7b (call it $12b). This data support Landon Thomas’ excellent reporting on the buildup of the cash reserves of various Gulf sovereign funds.
Russia was selling everything as its reserves fell, but it clearly was selling its Agency holdings faster than its Treasury holdings. It cut its holdings of short-term Agency paper by something like $8.6b (using other short-term custodial holdings as a proxy for Agencies)
The most recent TIC press release is interesting for another reason. The data on total flows in the 12 months through August 2008 and be compared to total flows in the 12 months through August 2007 (or even better, July 2007) to provide a fairly clean pre-crisis and post-crisis comparison.
Here as well two stories emerge:
a) Total demand foreign demand for US assets fell after the August crisis
Net flows in the TIC data went from $879b in the 12 months to July 2007 to $314b in the 12 months to August 2008 (line 30). Private flows (a number that includes a lot of official flows, notable “private” purchases of Treasuries and Agencies by private banks that are then sold to central banks during London trading) tell from from $665b to $18b. Official flows — which the TIC data understates — rose from $214b to $296b. The swing in long-term flows is a bit less pronounced but still substantial — total long-term flows fell from $1252b in the 12 months to July 2007 to $798b in the 12ms to August 2008.
b) Demand shifted away from Agencies and Corporate bonds toward Treasuries.
This is where the long-term flows tell a dramatic story. Let’s focus on total foreign purchases rather than the private/ official split, which is known to be off. Just remember that almost all Treasury and Agency purchases have come from the official sector. In the 12 months to July 2007, foreign investors bought $217b of long-term treasuries (and sold $10b of short-term Treasuries) while buying $284b of Agency bonds, $540b of corporate bonds and $210b of US equities. In the 12 months to August 2008, foreign investors bought $389b of long-term treasuries and another $134b of short-term Treasuries, bringing their total purchases of Treasuries to $523b (that is how the fiscal deficit was financed … ). Purchases of Agencies fell to $121 billion, purchases of corporate bonds fell to $193b (with almost $60b coming from official buyers, mostly in Asia) and purchases of equities — counting the $35b or so of bank equity bought by sovereign funds — fell to $97 billion.
The story is simple, at least in my view. Most foreign demand for US assets over this period came from central banks. And they increasingly only wanted to buy Treasuries.
UPDATE: Here is a graph of foreign holdings of long-term Agencies. Notice the recent fall.
The TIC data can be found here. This report draws on both the short-term stock data and the long-term flow data.
I am a layman in economics. But I surely have enough common sense to think that in times of crisis Gold and Silver would act as the saviour. But it just seems to act in the opposite direction violating all laws that govern it. This is not a bubble but a high tension spring highly compressed which when released would surely sent shockwaves. I really doubt anyone can dispute this theory
“The story is simple, at least in my view. Most foreign demand for US assets over this period came from central banks. And they increasingly only wanted to buy Treasuries.’
Can we conclude that this was some sort of warning sign?
[...] The mysterious August dollar rally; it wasn’t supported by any uptick in foreign demand for US ass… [...]
As far as the mysterious dollar rise goes, I did find some evidence to support the notion that it is in fact equity market driven, which as far as I know does not get picked up by TIC data.
This site here is a pay site, but the home page clearly indicates that is what they have measured. But a subscription would be nice to understand what they are talking about better.
They show for 3Q totals, $50B in net stock flows to US markets and $40B to money markets. Bond flows rather neutral as the TIC data seems to indicate. But the $90B of 3Q net inflows seems significant.
http://www.epfr.com/
This is making me kind of dizzy, but I would explain it like we had a net investor kamikaze run for US equities, then they got blown away already with their dollars never to be seen again.
Also a run for money markets, and the commercial ones like Reserve Fund are holding their dollars prisoner. There are treasury only money market funds, but I have no idea if those are picked up in the TIC data or not.
the TIC data should pick up equity flows (i am not sure about money market funds … in principle, they should show up but i haven’t quite figured out where to look). the TIC data for July and August tho doesn’t know big inflows into US equities. foreigners were sellers in july and august to the tune of about $7b. Americans were net sellers of foreign equities to the tune of about $20b.
I’m wondering how TIC works with flows through London and offshore accounts in the British Virgin Islands and the Cayman Islands. Lots of hedge funds.
Caymans/ Caribbean is considered a hedge fund proxy. So much moves through London that it is a mix of everything, including lots of central bank flows (I infer this from the pattern of revisions associated with survey, which consistently revise the UK’s holdings of Treasuries and Agencies down)
The data gets added up differently on the EPFR site. They don’t try and distinguish between foreign and domestic investment and what direction each is going in. They just are graphing the net result. This is broken down into a equity amount, US bond amount (which must lump together Treasuries, GSEs, and corp bonds, maybe munis), and money markets (which must lump together commercial and government types).
In the case of equities, there seems to be a pretty big discrepancy with TIC, and offshore hedge fund reporting sounds like as plausible an explanation as anything.
Seems believable that TIC may pick up t-bill action in money market funds in some direct way. But with commercial paper I have no clue.
Just a thought. A lot of countries, especially emerging economies, enjoyed unrealistically high currency exchange rates over the past few years. Add to that a large amount of foreign currency loans. If I were a citizen of let’s say Bulgaria or Serbia, I would have been racing this summer to exchange my local currency into a global currency, like the dollar. Citizens of Iceland can tell you how much they would have liked to do that. Could that have been a contributing element?
Marc:
It is net flows, so an influx of foreign money to US money markets could be part of the $40B.
It’s just ironic that we keep hearing they are frozen up on the asset end, some have got hit with withdrawals, but the new deposit end got another $40B.
Massive deleveraging by hedge funds is responsible for the US Dollar rally. And don’t forget that oil is still only sold in US$.
The Fed balance sheet exploded again this week, with “other assets” (including currency swaps) now at $ 450 billion.
DJC: Massive deleveraging by hedge funds is responsible for the US Dollar rally. And don’t forget that oil is still only sold in US$.
This is false no matter how often it gets repeated. Oil is *priced* in dollars, but you can buy it in any currency that you want.
True. We forgot commodities completely. That would explain the post summer strength in the dollar. Then the IBs upped the margin requirement by a factor of 2 or 3 on hedge funds accounts the first two weeks in oct. We saw a few pennies rise on the dollar index over that time frame.
Twofish,
By secret agreement negotiated with Henry Kissinger, Saudi Arabia Aramco only accepts petro US Dollars for their oil. Period. Iran and Venzuela accept Euros and yen, but Saudi Arabia remains the elephant on the room concerning OPEC global oil production. Not surprisingly, Iran and Venezuela also remain on the Pentagon’s “regime change list” for their oil export policies. We all know what happened to Saddam Hussein after he denominated Iraqi energy sales into Euros. Now Iraq oil sales are completely denominated in US Dollars with the proceeds held by the New York Federal Reserve.
Quote of the Day:
“Every person in the (rich) United States has over the past 10 years or so borrowed about $4,000 from someone in the (poor) People’s Republic of China.” – James Farrows
http://www.prudentbear.com/index.php/commentary/featuredcommentary?art_id=10129
High levels of debt are sustainable provided the borrower can continue to service and finance it. The US has had no trouble attracting investors to date. In recent years, the United States has absorbed around 85% of total global capital flows (about US$500 billion each year) from Asia, Europe, Russia and the Middle East. Risk adverse foreign investors preferred high quality debt – US Treasury and AAA rated bonds (including asset-backed securities (”ABS”), including mortgage-backed securities (”MBS”)).
Warren Buffett in his 2006 annual letter to shareholders noted that the US can fund its budget and trade deficits as it is still a wealthy country with lots of stock, bonds, real estate and companies to sell. In reality, a significant portion of the money flowing into the US was not used to finance productive investments but funded government spending and (sometimes speculative) property.
The real reason that the US actually has not experienced a sovereign debt crisis is that it finances itself in it own currency. This means that the US can literally print dollars to service and repay it obligations.
In February 1988, Thomas Moore, a member of the Presidents’ Council of Economic Advisors recognised this: “We can pay anybody off by running a printing press, frankly… so it is not clear to be how bad [the transition to net debtor status] is.” In other words, the dollar printing presses could be run to service debt.
The dollar’s favoured position in trade and as a reserve currency is based on complex network effects. Many global currencies are pegged to the dollar. This creates an outflow of dollars (via the trade deficit that is driven by excess US demand for imports based on an overvalued dollar). Foreign central bankers are forced to purchase US debt with dollars to mitigate upward pressure on their domestic currency. The recycled dollars flow back to the US to finance the spending. This merry-go-round is the single most significant source of liquidity creation in financial markets. Large, liquid markets in dollars and dollar investments are both a result and facilitator of the process and assist in maintaining the dollar’s status as the world’s primary reserve currency.
JKH — the fed balance sheet data is stunning. It will be the topic of my next post. annualized the increase in custodial holdings of treasuries over the last two weeks topped $1 trillion …
and the fed’s extension of credit to the financial sector was growing even faster …
DJC — another way of looking at it is that every person in china has loaned about $1000 to the US (and maybe $500 to Europe); I have long argued that this was not the best use of the savings of a relatively poor country like China.
Not so mysterious really, if you are an old trader. Currencies are priced relative to each country’s economic health. Initially, it was America’s economy that was viewed as weakening relative to other world economies.
Then all of a sudden everyone else caught the cold, the financial crisis recession. When Commodities turned down, it was the signal that other economies were actively cutting purchases and production, thus actively participating in a recession with the USA. As a response, other currencies began to weaken relative to the dollar.
It is not that America’s economy is strengthening, but that all the other economies are weakening.
Tying Currencies to money flows does not work, never has and never will. What makes sense is what works and what works has always been how traders view economic health in it’s aggregate. The trick is knowing what really matters.
The real world is messy and probabilistic. I would study probability economics as a suggestion.
Arnold T — I agree with most of your explanation, but with two caveats:
a) a shortage of $ liquidity among European banks and a general deleveraging also played a role. Japan’s outlook has deteriorated but the yen still appreciated b/c of a carry unwind
b) such shifts in views often translate in some way into flows. You see this with US investors pulling back from investments globally — a $ supporting flow. But there hasn’t been any visible flow indicating a rise in foreign demand for US assets relative to say European assets that leads to more inflows to the US.
I would expect such a flow to appear in some way — as traders views get reflected in money movements into the US. But it just wasn’t there in the August data
Brad,
Really enjoying having found your blog, but I’m not a big fan of the tic data, (or flow of funds analysis wrt exchange rate determination for that matter). Having spent over a decade on the FX desks of 3 different global banks, I’ve come to the conclusion that the FX market discovers fx rates, but it generally does not determine them.
to wit:
Lets assume that the Dollar is stable on foreign exchanges and the both the supply and demand for Dollars and the supply and demand for, lets say, Euro are in perfect equilibrium. In this fantasy world, I am a multi-billionaire, of course. Suddenly, I decide I’m afraid of the banking system and I withdraw $25bn each from my accounts at Citi, JPM, Wells, and BoA, and I bury the money in a gigantic coffee can in my back yard. The equilibrium has now been upset as the result of my spontaneous, massive demand for Dollar liquidity. It’s illogical to think that I haven’t effected the value of the dollar by my actions, just because I haven’t acted directly in the FX markets. I would contend that what would happen next, the equilibrium having been upset, is that the next person who needed to buy USD and sell Euro, for whatever reason, would find the price “gapping” against him towards wherever the new equilibrium might be.
I’m not sure what such a chain of events would show in the TIC data, but its my suspicion that in the current environment cross-border transaction data will prove a poor indicator of FX movements.
I smell hanky panky. I cannot see how the dollar can rally given these minute (relatively) levels of inflows. It smells.
Soxfan:
I’ve had similar thoughts of heresy. Generally I try to limit my thinking to FX transactions (or lack of them in the case of surplus CBs re-cycling dollars to peg currencies) are the cause of currency movements. I’ll even believe interest rate futures markets in currencies have a lot to do with it, since a lot of trade goods and financial instruments are legitimately currency hedged this way. And I’ve seen correlation charts to prove it, tho like you say its hard to tell from a chart who’s chasing whom.
And I think a trade deficit puts pressure on FX if it doesn’t all come back in re-cycled dollars.
And I generally believe that if you use dollars to buy and sell oil in dollars, or anything else denominated in dollars, that is currency neutral even if you do it from Grand Cayman. (other that trade deficit effects not offset by re-cycling).
But I do get a nagging suspicion that if enough oil spectulators are involved, like enough to move the oil market between $140 and $70, and they are using huge leverage, and they all start getting margin calls, they all start screaming…I NEED DOLLARS !
So I think that could have an impact over at least a few months.
Also, I should probably clarify that I didn’t mean to give the impression that I’m ignoring economic performance in the above explanation. That is all condensed in the interest rate futures markets. They spend their days analyzing all the econ data trying to get the jump on what CBs will do with interest rate policy. And the CBs are analyzing the economy trying to figure out what they should do about interest rate policy.
Then the futures markets decide on what they think the future spreads are between cross currency interest rates.
So a massive amount of economic analysis analysis and forecasting happens. Then they do over again the next day with any new news or data that comes out.
ould the swing not be so much a rally on the “merits” of the US$ but rather the fact that some many of the other currencies were overvalued , even by today’s standards?
Yeo:
Valuation is of course the whole point. But why the valuations? And how does the change in perceptions show up in flows, or perhaps short term dislocations in dollar denominated markets is what is good to try to get a handle on.
The yuan is not anything like a freely traded currency. But in the case of the rest of the BRICs, FDI in hot stock markets, and maybe in direct bank lending, had a lot to do with currency valuations. On the order of trade factors at least. It also swelled apparent CB reserves in these countries.
Also, the Euro is a new major currency challenging the dollar as a reserve currency, or at least being a candidate for a diversified basket of currencies, which is one solution to global currency risk.
In the case of the yen, Japan has a substantial amount of private investment. ZIRP and quantitative easing caused all this to go looking elsewhere for yield, mostly to the US. The unwinding of this is a major factor in yen/dollar strength.
So FDI flows are important. In the case of the ’90s dollar, we first had Greenspan rapidly raising interest rates in 1994, giving the dollar a boost. We also had relatively modest twin deficits. But then the late ’90s stock market boom attracted a lot of FDI chasing it and the dollar index hit near 120 ! Far cry from today. Now it’s looking like a Treasury boom could take it as high as 85.
I’ve never really understood the point of applying valuation metrics to two pieces of paper.
Soxfan:
Distaste for the barter system is the only one I can think of.
Brad says:
Don’t ask me to explain how the US has sustained a $120b trade deficit in July and August on the back of a $34b net outflow of funds over those two months in the TIC data. Something doesn’t quite compute.
The simple explanation is to assume the two flows have no causal relation to each other.
The trade deficit was produced or due to the purchases of foreign made goods in every nation in the world that trades with the U.S. The outflows were produced by the market forces for currency and currency transformation into other forms of financial assets.
The reason the dollar has enjoyed its recent surge is pretty simple, and it is not because the dollar is viewed as a safe-haven, despite what our media feeds us. Banks all over the world were denominating their loans in U.S. dollars out of pure habit, and now that they are canceling their lines of credit and demanding repayment businesses/people are forced to buy U.S. dollars to repay the loans. This has forced demand for the dollar way up, and at the same time forced down other currencies as they are sold. The yen is also experiencing a similar phenomena.
It is purely because of transactional reasons. There is no reason to view the dollar as any safer than the yen, for example, as in Japan their banks are in pristine condition.