from Follow the Money

On the December TIC data

February 17, 2009

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Note: this post is by Rachel Ziemba, filling in for Brad Setser

I can’t hope to do as good a job as Brad in parsing the TIC data, but a couple of trends seem to emerge at a quick glance of December’s data. As usual my eyes always stray to the role that China and oil exporters play in financing the U.S. so its worth noting that Chinese reduction in short-term holdings meant that it had net sales of $8b in U.S. assets during the month, the first decline since February 2008.   While most of the trends that having been playing out since September persist (increasing role of private American investors, reduced role of several central banks given reserve accumulation slowing or reversal) there are some differences including a renewed appetite for U.S. corporate bonds and a slower pace in the demand for T-bills.

Foreign investors continue to be wary of U.S. long-term assets, especially agency bonds. They (especially foreign central banks) have been net sellers of agency bonds since Fannie and Freddie’s solvency was called into question last year and December marked no change with net sales of $37 billion. Foreign investors did buy more treasury bonds but continued to make only anemic purchases of U.S. stocks.

However net purchases of corporate bonds picked up significantly in December, with net purchases of $41 billion, the highest monthly net purchases since May 2008. Between them the UK and Switzerland accounted for most of the net purchases, accounting for $23 billion and $11 billion respectively. This new appetite for corporate bonds may reflect some attempted arbitrage using the bonds and the CDS. My colleague Elisa Parisi-Capone earlier highlighted this trend noting that with cash bond spreads above their respective CDS indices in both the investment grade and high-yield markets (negative basis) several Investment grade bonds look cheap and investors might buy both a bond and credit protection to lock in a risk-free yield - with only counterparty risk remaining – not insignificant in some cases as credit quality is deteriorating.

The massive flight to short-term U.S. assets since September has ebbed slightly , with several countries including China paring their holdings of U.S. short-term claims in general and T-bills in particular. Total foreign holdings of short-term U.S. securities increased only $2.1b in December (+$51.1b in November) . Foreign holdings of Treasury bills increased $25.3b (from $82.1b in November) with official institutions buying $30b. Chinese holdings of short-term claims fell by about $11 billion after rising over $50 billion per month for the previous three months. Asian oil exporters, aka the gulf also reduced their holdings of short-term assets by about $7b. In both cases the reduction in short-term holdings more than offset net purchases. Russia bucked the trend, adding more short-term claims as they continued to sell (or not buy back) agency holdings. Russian corporates and banks were taking advantage of slow depreciation to shift from rouble to dollar holdings.

The wholesale shift to short-term assets may no longer be proceeding at its unsustainable pace but still seems underway, at least for some official actors as they perceive higher financing needs to provide capital to domestic banks – and may be holding out for the higher yields to come as the supply of US debt issuance rises. The pace of the shift to short-term claims was in some cases so great that it had to be unsustainable. in China’s case, the over $150b in short-term claims added in Sep-Nov likely reflected a shifting between U.S. assets to those picked up by the TIC data rather than those more hidden holdings like money market funds. Yet with the treasury having increased its reliance on bills financing, a protracted shift away from T-bills could have broader ramifications. But given that Foreign official institutions continued to add $30b in T-bills, it stands to reason that in current conditions, central banks might continue to move to the short-end, given their perceived liquidity needs, particularly in those countries whose banks and corporate have fx financing needs.

However, even as U.S. treasury issuance is set to increase dramatically given the fiscal stimulus, recapitalization of the banks pushing the U.S. fiscal deficit above $1.6 trillion (according to the CBO) the demands from foreign central banks are likely to be lower in 2009 than they were in the early part of 2008. However, with the saving rate on the rise, US investors may well account for a considerable share of purchases.

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