This is Rachel Ziemba. Brad will I think be back soon but I figured I’d get in one last post going into some excessive details on the Treasury International Capital (TIC) data.
These days, the TIC data released monthly by the US Treasury and detailing the capital flows to and from the U.S. often seems anti-climactic given sharp moves in the fx and treasuries market. Despite the lag, data released yesterday and detailing May purchases tells a few interesting stories.
Most importantly, it illustrates the fact, that in the face of capital inflows to overheating emerging market economies in May, the central banks of these countries kept buying U.S. dollar assets. Q2 has been the first quarter of significant reserve accumulation of the last year. Preliminary estimates we’ve done at RGE Monitor suggest that reserve accumulation was around $180 billion in the quarter (adjusted for valuation), the first significant increase since mid 2008. As in 2008, China accounts for the bulk of the accumulation.
Despite supra-national reserve currency rhetoric given the reluctance for currency appreciation, there was little choice to buy dollars. China added $38 billion in U.S. short and long-term treasuries - a net increase of $26 billion in U.S. short and long-term assets. The discrepancy can be explained by China’s reduction in its USD deposits and continued reduction in agency bonds.
However, they shunned the long-term assets. The major foreign buyers of US assets went back to the short-end of the curve, buying T-bills and adding other short term claims. Total purchases of T-bills by foreign official investors were $53.1 billion.
This move could help explain why long-term treasury yields rose in May. With concerns about the U.S. fiscal position, worries expressed by major U.S. creditors about the dollar’s value, perhaps the move to the short-end of the curve is little surprise. It also suggests that the U.S. government is again becoming more reliant on bills financing as it was towards the end of 2008. This may not be sustainable in the longer-term.
While the decrease in the US current account deficit means that the U.S. may be less reliant on foreign finance in 2009, the U.S. has become even more reliant on China as a share of its foreign finance. China has been the largest reported holder of U.S. treasuries for some months now. But as of May China now accounts for 20% of total outstanding foreign holdings and almost equals the combined holdings of Russia and Japan.
Since last fall, China dramatically scaled up its purchases of the shortest term, most liquid U.S. assets. It has purchased $196 billion in treasuries of less than 1 year maturity from July 2008 to May 2009. In part this might reflect a shift last fall within China’s US dollar portfolio. It also vastly decreased its holdings of US agency bonds, while slightly adding long-term treasuries.
However, as the chart below shows China’s purchases of long-term US assets fell sharply in the last year and continue to fall.
12 month rolling sums of Chinese purchases of U.S. assets
So why short-term assets? Investing the most liquid assets could keep funds freer for other purchases, including the extension of dollar denominated loans to resource countries. In theory, with shorter maturities, China could allow these assets to expire and not re-purchase them. However, in an environment where Chinese growth is re-accelerating, Q2 is unlikely to be the last with hot money inflows. As a result, expect further dollar purchases. No wonder Chinese officials were worried about USD holdings this spring given how many US assets they were buying.
Like China, Brazil also added short-term claims in May, with $12 billion in short-term claims offsetting net sales of $9 billion in treasury bonds. Short-term treasury holdings rose by almost $10 billion. Brazil has also been wanting to diversify its reserve holdings.
What of the Gulf, the major creditor region, visited by the Treasury secretary this week? Asian oil exporters likewise added to short-term holdings in May, prompted likely by local liquidity needs even more than dollar value worries. Given lower oil prices, the regions sovereign wealth funds have fewer new funds at their disposal. That may be changing slightly, yet, the increase in domestic spending and reduction in oil output limit new funds available. Meanwhile with the shifting from the dollar peg off the table as a policy option reserve diversification is limited. Moreover, given the pegs, their need for dollar liquidity and dollar financing remains high.
Based on the reported data, the GCC has a reported dollar portfolio of about $400 billion - $140 billion in U.S. equities, which hasn’t budged much in the last 2 years. Holdings of long-term treasuries increased from by about $30 billion from June 2008 to May 2009 to almost $200 billion despite a slight decrease in May. Holdings of Agency bonds fell by about $10 billion though.
The GCC total dollar portfolio is likely significantly bigger – over half of the estimated $2 trillion managed by public and private sector GCC investors. The discrepancy can be explained by the GCC tendency to buy through intermediaries. However, it seems likely that the use of local intermediaries has increased. The flows from the GCC have been higher in the last year. But again, the currency pegs may constrain the GCC to dollar purchases.
Japan, Russia and Canada, had notable net sales of U.S. assets in May. Japan’s shrinking current account surplus could reduce the amount of US assets it buys.
Canada’s sales may reflect the shift away from government bonds to equities outside of the U.S. in the midst of the rally.
Russia’s net sales, mostly of short-term assets, seem to be a bit more puzzling. Russia has been reducing its U.S. dollar assets from some time but given the inflows Russia received, one would have expected dollar purchases. In fact Russia’s central bank data on its fx interventions suggests that it bought $18 billion in US dollars in the month of May. Russia could be adding to offshore dollar deposits that would not be captured in U.S. data.