A Contrarian Take on the Foreign Flight from U.S. Assets
There's been much hand-wringing over data suggesting a big pullback in foreign investment flows into the U.S. Digging into some of the more arcane aspects of the activity can both confirm the worries and contribute to something of a contrarian perspective.
The idea that foreign official accounts have been selling Treasuries isn't new. In fact, it's been going on for more than two years, according to both Treasury Department and Federal Reserve data. What hasn’t gotten much attention is that to a large degree official selling has been offset by private investors -- the bulk of them in Asia -- buying Treasuries, mortgage bonds and agency-related fixed-income.
In other words, there’s been as much a reallocation of investments in the broadest context than a wholesale liquidation of dollar-denominated assets. This also speaks to a divergence between central banks and private activity. The inference is that the selling, or reduction, in Treasury holdings isn't an interest rate bet, per se, but about reserve management. The buying of other fixed-income assets suggests a rather benign view of the rate cycle and even hints that there will be further buying interest if rates back up further.
Let’s start with the big picture of the Treasury's TICS (Treasury International Capital Systems) flows. What’s evident is that there’s been some deep selling of Treasuries since about mid-2014 by foreign official accounts such as central banks flows, which show a from about $4.2 billion to $3.8 billion as of December. A lot of that is related to China’s shrinking foreign-exchange reserves, which are now a hair under $3 trillion after peaking at about $4 trillion in 2014. Japan’s reserves are $1.17 trillion, down from a peak of $1.22 trillion in 2012. The Fed's Custody Holdings stand at $3.16 trillion, after having topped out at $3.38 trillion in mid-2015.
The details of the TICS data can be misleading because of a quirk in initially measuring where the buying or selling is coming from, rather the ultimate buyer or seller. For example, between November 2013 and March of 2014, little Belgium saw its holdings of Treasuries rise from less than $150 billion to more than $350 billion. Either the country sold an awful lot of chocolate or some other foreign entity parked their money there for a while. We can speculate on whom that was, but the more telling point is that today Belgium holds less than $90 billion.
Now consider foreign holdings of agency securities and, to a lesser degree, corporate bonds. When selling of Treasuries started in 2014 there was dramatic ramping up of agency/mortgage bond securities buying and a significant, if much more modest, increase in corporate bond purchases.
The agency/MBS purchases hit record levels in 2016, surpassing the aggressive purchases seen before the financial crisis. Since June 2014, officials sold $569 billion of Treasuries while private buyers bought $434 billion in agency/MBS and $266 billion in Treasuries. (Caution: this is potentially misleading since I’m looking at monthly purchases and haven’t input redemptions or maturing issues that were simply rolled over into new securities. The Treasury reports that as of November, official accounts owned $3.81 trillion in Treasuries out of the $6 trillion outstanding. As of November, foreigners held $968 billion in agency/MBS with $528 billion owned by private investors and $440 billion by officials. Contrast that with the trough in 2014, when privates owned just $390 billion in agency/MBS.)
And who is doing all that agency/MBS buying? The answer is largely Asia, the epicenter of Treasury selling. Of the $13 billion agency/MBS bought in November by private buyers, $12 billion was purchased by Asia, with Japan, China and Taiwan taking a combined $11.7 billion. The buying wasn’t an anomaly, especially since there's typically a drop in buying in Decembers. These countries were net buyers for most of last year, with Japan leading the way.
EPFR (part of the firm I’m with now) measures the flows in and out of mutual funds and exchange-traded funds across the global asset class spectrum. There’s been steady buying in MBS on a cumulative basis, which conforms somewhat to the two-month delay in the TICS data. There was a big acceleration in purchases at the start of the year before the momentum slowed in the latest week.
Corporate bond buying has surged in recent weeks on a cumulative basis. Treasury Inflation-Protected Securities have also seen strong and consistent buying. Without overlaying the data with other variables, such as interest-rate differentials and/or exchange rates, it's safe to say that the much touted selling in Treasuries by central banks is only one side of a multifaceted story.
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