from Follow the Money

Bill Gross, eat your heart out … Norway is the new bond king (The SeptemberTIC data)

November 16, 2006

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Blog posts represent the views of CFR fellows and staff and not those of CFR, which takes no institutional positions.

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No one seems to have timed the US Treasury market better that the Norwegian Government pension fund.    

In the first half of the year, Norway shortened the maturity of its dollar portfolio – adding $33.5b to its short-term claims and selling $23.7b of long-term claims (including $18.2b of Treasuries).     That was back when yields were rising/ the value of long-term bonds were falling. 

In the third quarter, it shifted back into long-term bonds … likely catching part of their rally.  Norway purchased $17.5b of long-term debt in the third quarter, in part by cutting its short-term claims by $3.7b.

Brazil did something similar, buying $14.3b of long-term debt, in part by reducing its short-term claims by $2.4b.  Indeed, my own proprietary work suggests that central banks collectively shortened the maturity of their portfolios in the first half of the year by building up dollar deposits even as they reached for a bit more yield in the Agency/ MBS market.

Those kinds of details are a lot easier to see with the Treasury’s new format for presenting the TIC data.    I love the new quarterly totals by regions.

But the big story, of course, if that no matter how you cut it, recorded flows in September (and indeed the third quarter) were too small to finance the US current account deficit.    The Q3 current account deficit looks set to approach $230b.      And if current trends continue, the US actually needs to raise a bit more than $250b a quarter to finance net FDI outflows.

Net foreign purchases of long-term securities – without adjusting for principal payments on agencies – were $212b.  Recorded inflows from official institutions provided $69b of that total.  Those are the numbers that we are used to seeing; they are the only numbers the Treasury used to report in its headline release.

But the new format provides a bunch of additional data.

  • Net long-term inflows, accounting for principal payments on Agencies, were $175b. 
  • "TIC inflows" – including short-term inflows – totaled $205b.   Total short-term flows were around $30b.

Those are large flows.  They just are not quite a large enough flows.

Two other trends are visible if you look at data long enough – one is, I think, real; the other is, I think, fake.

The real trend is a deterioration in what emerging market analysts would call the “quality” of the financial flows coming to the US.     

Net long-term flows have been flat since 2004 – they were $725b in 2004, $698b in 2005 and $730b in the last four quarters (Q4 2005-q3 2005).      They have gone from exceeding the US deficit to not quite covering it.

Short-term flows provided $254b in additional financing in 2004.  Short-term claims on the US fell in 2005 – with a $31b outflow.   But they have provided $174b of net financing over the last four quarters.     

The dip in 2005 wasn’t a problem for two reasons.  First, the Homeland Investment Act led to a turn around in net FDI flows, so the US needed less financing.  Second, the huge build-up of short-term claims in 2004 came on top of long-term flows that were more than enough to finance the US deficit – so the Us had a bit of a cushion. Literally.   I suspect that the enormous central bank intervention in q4 2004 led to a build up of short-term claims that were invested in long-term term securities in the course of 2005.

The fake trend (in my view) is the fall in recorded (net) official financing from $342b in 2004 to $87b in 2005 and $137b in the last four quarters.   Why do I say that is a fake trend?   Simple: there hasn’t been a comparable fall off in global reserves growth, which has been close to $700b since 2004.    More on this later. 

Four other points.

  1. Net Japanese purchases of long-term securities were strong in Q3, around $21.8b, with over half of the total purchases of Agencies.    Japanese purchases were also strong in q2, but not in q1.  In q1, Japan was a net seller of long-term securities and an even bigger net seller of Treasuries.   This is why I think the MOF has been slowly shifting its portfolio away from Treasuries toward Agencies. 
  2. The Russians have bought about $5b in long-term US securities (mostly agencies) every quarter of 2006.    But don’t be fooled.  In every quarter, they have reduced their short-term holdings (mostly agencies) more than they have increased their long-term holdings.    For the year, Russian short-term holdings have fallen by $52.2b, more than offsetting their $16.6 in long-term purchases.  Total Russian claims fell by $35.6b this year.  True BoP geeks know that this has been offset by a comparable rise in Russian deposits in the international banking system.    There is good reason to think Russia has diversified its reserves over the course of 2006.
  3. Long-term security purchases by Asian oil exporters (think the Gulf) were only $4.8b in q3.   That is down from $11.6b in q2 and $8.6b in q1.    Moreover, the Gulf countries are running a current account surplus of around $50b, if not a bit more, per quarter.   Any reasonably estimate of the dollar share of their portfolios would imply far larger purchases.  Hello, London custodians. 
  4. China bought about $26b of US long-term debt (1/3 of that was Treasuries, 2/3s Agencies and corporate bonds).  It also increased its short-term claims by $20b, so it provided $46b in net financing to the US.   That is about ¼ of all inflows.   Chinese long-term purchases have been fairly stable over the course of the year -- $30.5b in q1, $28.2b in q2 and $25.9b in q3.   In q1, however, China financed its purchases of long-term debt by running down its short-term claims, in q3 it was building up both its short-term and long-term claims. 

In the first three quarters, China bought around $28b of Treasuries, $33.5b of Agencies and $22.9b of corporate bonds (MBS) – for an overall total of $84.5b.    It also increased its short-term claims on the US by a total of around $8.6b.    total inflows top $90b.

I still think though that the recorded inflows understate total Chinese purchases …   If you combine net FDI inflows and China’s current account surplus, China will have the capacity to purchase around $300b of the world’s debt this year.    If 2/3s  of that goes to dollars, that implies a total flow of around $200b. 

I would bet some of Hong Kong’s purchases of long-term securities -- $11.6b in q3, $13.1b in q2 and $24.4b in q1 – should probably be attributed to China.  

Just a hunch. The HKMA’s reserves aren’t growing by that much …

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