There’s now a special math for NIRP refugees in Europe.
It started with a whimper a couple of years ago and has turned into a roar: foreign governments are dumping US Treasuries. The signs are coming from all sides. The data from the US Treasury Department points at it. The People’s Bank of China points at it in its data releases on its foreign exchange reserves. Japan too has started selling Treasuries, as have other governments and central banks.
Some, like China and Saudi Arabia, are unloading their foreign exchange reserves to counteract capital flight, prop up their own currencies, or defend a currency peg.
Others might sell US Treasuries because QE is over and yields are rising as the Fed has embarked on ending its eight years of zero-interest-rate policy with what looks like years of wild flip-flopping, while some of the Fed heads are talking out loud about unwinding QE and shedding some of the Treasuries on its balance sheet.
Inflation has picked up too, and Treasury yields have begun to rise, and when yields rise, bond prices fall, and so unloading US Treasuries at what might be seen as the peak may just be an investment decision by some official institutions.
The chart below from Goldman Sachs, via Christine Hughes at Otterwood Capital, shows the net transactions of US Treasury bonds and notes in billions of dollars by foreign official institutions (central banks, government funds, and the like) on a 12-month moving average. Note how it started with a whimper, bounced back a little, before turning into wholesale dumping, hitting record after record (red marks added):
The People’s Bank of China reported two days ago that foreign exchange reserves fell by another $12.3 billion in January, to $2.998 trillion, the seventh month in a row of declines, and the lowest in six years. They’re down 25%, or almost exactly $1 trillion, from their peak in June 2014 of nearly $4 trillion (via Trading Economics, red line added):
China’s foreign exchange reserves are composed of assets that are denominated in different currencies, but China does not provide details. So of the $1 trillion in reserves that it shed since 2014, not all were denominated in dollars.
The US Treasury Department provides another partial view, based on data collected primarily from US-based custodians and broker-dealers that are holding these securities for China and other countries. But the US Treasury cannot determine which country owns the Treasuries held in custodial accounts overseas. Based on this limited data, China’s holdings of US Treasuries have plunged by $215.2 billion, or 17%, over the most recent 12 reporting months through November, to just above $1 trillion.
So who is buying all these Treasuries when the formerly largest buyers – the Fed, China, and Japan – have stepped away, and when in fact China, Japan, and other countries have become net sellers, and when the Fed is thinking out loud about shedding some of the Treasuries on its balance sheet, just as nearly $900 billion in net new supply (to fund the US government) flooded the market over the past 12 months?
Turns out, there are plenty of buyers among US investors who may be worried about what might happen to some of the other hyper-inflated asset classes.
And for long suffering NIRP refugees in Europe, there’s a special math behind buying Treasuries. They’re yielding substantially more than, for example, French government bonds, with the US Treasury 10-year yield at 2.4%, and the French 10-year yield at 1.0%, as the ECB under its QE program is currently the relentless bid, buying no matter what, especially if no one else wants this paper. So on the face of it, buying US Treasuries would be a no-brainer.
But the math got a lot more one-sided in recent days as French government bonds now face a new risk, even if faint, of being re-denominated from euros into new French francs, against the will of bondholders, an act of brazen default, and these francs would subsequently get watered down, as per the euro-exit election platform of Marine Le Pen. However distant that possibility, the mere prospect of it, or the prospect of what might happen in Italy, is sending plenty of investors to feed on the richer yields sprouting in less chaos, for the moment at least, across the Atlantic.
This is the closest the Eurozone has come to falling apart. Read… What Would it Cost a Country to Leave the Euro? That’s What Everyone Suddenly Wants to Know
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Treasury securities are considered cash equivalents and they are the collateral of choice in the financial markets. If you can buy treasuries cheaper than other assets of similar duration, you can use them in a swap transaction, then you let the other party keep the collateral. It’s an arbitrage. You are swapping assets of equal face value but you bought yours cheaper, so you make money on the swap.
Its a panic trade and not at all about trade adjustments?
See JimTan’s comment lower down.
He seems to have discovered the parties to the trade. If he is correct then the trade is in swapping Treasuries for commercial paper in money market funds. This can be extremely profitable because commercial paper is higher yield and extremely marketable. You can sell the paper and pocket the profit right away, no need to wait for Treasury maturity.
Thanks for this article. Wolf, please comment on the letter the White House sent to the FED regarding its opaque and secretive dealings with foreign banks.
There has been real change in the bond market, with more bloodshed to come, JMHO. Let’s see how long i. the S&P 500 can stay above 2,300 and ii. other European markets will slavishly follow it.
Does it make sense? One Head Cheerleader has a following. She is doing well and all others are good by association?!?
That letter (fr a Rep Congressman) had to do with the Fed regulating the banks. The White House wants the Fed to back off its regulations of banks, including the US entities of foreign banks.
The last thing this country or the world needs is to roll back banking regulations. What we need is a modern version of Glass-Steagall.
I don’t disagree that regulation is needed. Anything that can be stolen will be stolen if there’s not a law specifically prohibiting it. Laws allowing theft (which will be called something respectable) will be written if accommodating politicians can be bought and paid for.
Where I am hesitant is, at this time, criticizing Trump for wanting to remove regulations. No, I don’t want poison water, toxic air, or thieving banks waiting for socialized losses to kick in once again. What I don’t know, and have to trust in – at this time – is that many current regulations were made toxic by opponents in an effort to get rid of them entirely. Just simple game playing over a long period of time. What I hope to see is Trump taking out the bad ideas and leaving the original intent. Time will tell.
So many of the screaming meamies who are going after Trump today are the ones who fear the loss of their ‘thing’ since he has so little respect for the Establishment and the schemes and/or scams they have built up over the decades. Free stuff or big pay for little work for the connected, paid for with debt, low rates, probable NIRP if Hillary or a stock Republican won, is at stake and a possible reward if Trump can be hounded under control.
Ironically, the Republicans (actually both parties) had the re-reinstatement of a modern version of the Glass-Steagall act in their platform. I wrote about it in July. We haven’t heard anything about it since the election – and as expected, that item in the platform looks deader than a door nail.
http://wolfstreet.com/2016/07/18/nightmare-on-wall-street-republicans-democrats-agree-on-reinstating-glass-steagall-act/
“What we need is a modern version of Glass-Steagall.”
Thank you!!!!!!!!
Or at this point Glass-Stiegel itself would be just fine.
Trying to discover how the hell the system works before they ad hoc gut the institution.
You mean half the banks and all the owners are European?
And we loaned more $ to a DJ on Ibiza than a farmer in OHIO?
Get the wonka-vator prepared?
“What we need is a modern version of Glass-Steagall.”
With TEETH, f big ones.
foreign Central Banks(CB) are mainly in short duration assets.
Less than 15% of their assets are over 10 years.
You can spot their activity in the $UST3M, $UST6M.
The $UST6M rate had an average rate of 0.05% in 2014.
It jumped since Oct 2014 crash to (X2) 0.1%.
Now, since Oct 2015 it jumped to over 0.5%, and since Oct 16
moved even higher to an average of 0.65%.
On every move up in interest rate, the value of bonds ¬es
goes down.
That’s the value of CB holdings. They might ,still sell or lend
their big banks, but the net reduction is less extreme.
Follow the KISS principle.
Why are Treasuries being dumped? IT’S THE DEBT.
The US dollar as reserve currency has allowed this high debt level.
Utilizing the under-pinning of the Petro-Dollar as its strength.
The petro dollar is now half dead and on its death bed.
When the worlds largest (Saudi Arabia) and second largest (Russia) oil producers are selling their oil to the worlds largest consumer (China) denominated yuan and by-passing the USD.
These nations now realize they don’t need to hold large US dollars reserves. That to their minds are now riskier to hold, because of the growing massive debt level. Other nations dispose of their dollars by buying oil, then selling it to China for Yuan, which they can now convert into gold bullion on the Shanghai Gold Exchange. Thus this growing movement to divest US Treasuries will accelerate.
Once the petro dollar is declared fully dead, the amount of inflation that will be unleashed, which is beginning to show up, will be eye popping!
Inflation only occurs if there is too much money chasing limited supply of goods.
The US debt is not a problem. As an issuer of their own currency, the Fed can simply keystroke digits to pay off debt. This won’t cause inflation since you’re actually destroying money (the debt).
The US can never default on its debt. Unless it was voluntary.
Hyori,
Japan’s end game. One week scandal. Hailed as brilliance afterward.
Also the ECB end game, but a bigger scandal since member nations must make up capital deficiencies at the ECB. Of course, a kick the can measure will be enacted to eliminate this need and exiters will be able to thumb their noses at sovereign debt they issued which is owned by the ECB. Two week scandal. Exiters prosper afterward.
“The US debt is not a problem. As an issuer of their own currency, the Fed can simply keystroke digits to pay off debt. This won’t cause inflation since you’re actually destroying money (the debt).”
This is incorrect.
If the government were to simply spend the money it needs without offsetting by creating debt, it is really money printing, which ultimately leads to massive inflation.
Daniel L:
Case 1: Fed prints and buys US debt, which will never be paid back, realistically.
Case 2: Fed prints only and donates proceeds to UST.
Difference: The pretense covers the intent. The former gives you certificates that are evidence of a loan. The latter provides no paper. The cost basis is the same for the Fed, $0.00. No loss is possible to the Fed, only to a secondary buyer who spends savings and doesn’t print it up.
Hey outlookingin,
I read the Grant Williams PDFs too. If he’s right and oil is returning to a gold based price, what does that mean in the US?
The way I see it is that we will have to put up more of our crap dollars to buy the same oil. But the dollar has been gaining strength against the other currencies. So if he’s right, the dollar will have to slide at some point and we’re still importing what, 9 million barrels a day?
What do you think?
Bucanero
Recent stats show Canadian oil imports into the US are greater than all of Opec combined. And Canadians will accept USD, often more so than C$.
A country’s debt and it’s currency are valued against all other currencies and all other debt. By that measure the U.S. is still going to be the cleanest dirty shirt for a long time to come.
regarding:
“And Canadians will accept USD, often more so than C$.”
That statement is true, provided the exchange is at par. Otherwise, not a chance.
It all hinges on confidence in the USD.
This is now slowly eroding, as can be deduced by the uptick rate of inflation and higher bond rates.
The massive amount of foreign held US dollars will eventually find their way back home. It is now a trickle, but when it becomes a flood, these loose dollars pour into the economy causing higher inflation rather quickly.
As far as the USD gaining strength against other currencies, a more realistic measure (other than the basket of currencies it’s measured against) is the value of gold. Which is at all time, or near all time highs in all other currencies. Except when measured in the USD it appears to be undervalued.
Gold is the asset of choice, rather than holding dollars.
I do appreciate the replies. But I’m wondering how all this will affect the WTI prices if this situation comes to pass or even worsens.
I own physical oil in tank farms that I also own. I’m small fry compared to the Goldman guys or countries, but when the market is favorable I can kick some ass. I’m still constantly moving oil and taking new in but at crap prices. I’m not in the “club” and guys like me only get a fair price when the club members are desperate for product. And they’re not.
So, the petrodollar withers away, in North America, how would it affect our pricing schemes?
Cheers to you all
“Other nations dispose of their dollars by buying oil, then selling it to China for Yuan, which they can now convert into gold bullion on the Shanghai Gold Exchange.”
1. Since the Yuan is pegged to the USD, other nations are not disposing of USD.
2. Holding “promises” of gold for Yuan is an extreme risk.
If “other nations” really want to go “all in” on the Yuan, then why the peg. China knows damn well the Yuan would crash without managing the peg; otherwise there would be no peg.
$100,000 USD will be lucky to buy a box of matches!
It is very good to know that US investors are among the main buyers. At this rate, the USA’s colossal debts will end up more or less contained within the country itself, rather than being used as levers to prise wealth out of the rest of the world.
For the small number of people who work in international finance, the reason for the sale of U.S. Treasuries is no secret. Banks in foreign countries, but especially China and Japan, have funded their massive trade surpluses by creating money out of nothing, denominated in dollars, because there was simply not enough real money to fund so many exports. This was fine as long as their trade surpluses were growing – the banks made big profits, and the virtual bills could simply be rolled over, on the assumption that real dollars could eventually be obtained. These virtual dollars now sit in the accounts of those banks, waiting to be matched to real dollar assets. But now, banks are no longer willing to gamble with virtual money, because ever since 2008, it’s been a losing trade, and the supply of real dollars simply isn’t enough for mercantilist countries to maintain their surpluses.
China and Japan have to sell down their treasury holdings just to maintain financial systems that are increasingly dollar short. If “capital flight” were China’s only problem, it would be relatively small potatoes. But China’s financial system is trillions and trillions of dollars short, far more than can be paid in foreign asset holdings alone. It’s not a question of if, but only a matter of when that shortage reaches a critical stage, and the Yuan collapses in a panic to obtain ever scarcer dollars. China has already reduced its surplus by a trillion, and it hasn’t dented the massive debt bubble that sits in the very center of its banks balance sheets. I wish I was smart enough to figure out a way to make money off of this, but for now, the fun is only just getting started.
POTUS values “being smart”.
He says Obamacare will fail on its own and advises forced-drafters to wait, or they will own the program.
Is he smart enough to wait for the Chinese financial reckoning to come, or will he “own” a counter-productive confrontation?
Agree with you Unitron….however if you DID find a way to make money off it….it would quickly become a crowded trade attracting the notice of Chinese officials who would actively work to pull the rug from under the trade.
Yes….the ‘fun’ is just starting.
I think I have one idea where some of these Treasury securities might have been picked up.
In October 2016, the SEC implemented a new rule removing an exemption which permitted money market funds to value all their securities at amortized cost. Money market funds previously valued all their holdings using an amortization calculation that gradually increased prices as each holding approached maturity on the assumption that everything would be held to maturity. Their new rule requires daily mark-to-market valuations for money market funds holding non-government securities ( corporates, munis, MBS/ABS, ect. ), but maintains amortization values for money market funds holding government securities ( Treasury Bills, Notes, Bonds ). Basically investors parking their cash in non-government money market funds can now incur losses, while cash investors in government money market funds do not.
As a result, in the lead up to October 2016 most money market funds have shed all their non-government securities and now hold only U.S. government securities. This shift by money market funds away from short term corporate debt is the main reason GE shed its GE Capital unit, one of the largest issuers of commercial paper. Money market funds hold about $2.7 Trillion in assets under management. These funds have been big buyers of Treasury securities over the past year. If you have an IRA or retail brokerage account with one of the big names ( Fidelity, Vanguard, ect. ) they have likely informed you this year that all cash will now be swept into government only money market funds. While money market funds by definition will directly hold only short term Treasury securities, they indirectly hold long term Treasury securities through repurchase agreements collateralized by Treasury Notes, and Bonds.
Presently a condition exists in my money market fund where the short term paper is above water.
The drain on the system is making 30 day paper trade at a premium.
The fed has been tightening since 2014; the bottom has dropped out of oil and yet its a crap dollar?
THE DOLLAR STRENGTH IS THE PROBLEM?
China needs to sell dollars or its local currency becomes crowded out?
JomTan, money markets have played a crucial role in supplying dollars to China and Japan, and its quite possible you are right. Not allowing foreign countries to hold so many treasuries would play a big role in reducing the trade deficit.
Sorry, I meant JimTan. Damn tiny iPhone keyboard!
Maybe the foreigners are just cashing out of the US bonds ($’s) while the dollar is strong. If they bought the bonds when the dollar was cheap an sold now they would have a nice little currency gain. With rates rising bond prices can only go down too. Just from those two points alone it would seem an attractive time to sell.
Unitron, bravo !!
Any oil producer that get paid in Yuan, get a diminishing currency..
The Dow look fantastic, way to go.
But it has an eerie look of major, previous downturns, adjusted
in time.
What backs the US Treasuries other than the US Government or basically tax revenues? If Russia, China, and Iran are trading oil for gold, and if Trump reduces taxes, how do you think the future will onfold? Oil controls trade, not the US dollar in the future.
High inflation when confidence in currency is lost and people scramble to buy real things (velocity) out of FEAR. The fed hitting alt print has to go a long way toward that situation at some point. Could be a global, simultaneous loss of confidence in central banks and currencies, given their exponential increase.
Will it lead to a Greekification of American debt? I have always believed our governments has no trouble borrowing because everyone is soooo eager to lend it. So we can just refinance the old debt with new debt, while also funding the welfare state with it. Is that changing? Does it mean there will be a time when we have to pay debt and interest out of our surplus?
Wrong conclusion.
Based on chart sales about 15B/month for maybe 15 months = 225B, which equals total sales.
This means only china has been selling, and all to slow falling yuan. And china likely thinks they can’t afford more cap flight, plus elites have had plenty time to get out… this will stop, though maybe big devaluation.
If china stops selling they will be buying because surplus. Unlikely fed will unwind because economy too weak.
Treasuries firming.
“Turns out, there are plenty of buyers among US investors who may be worried about what might happen to some of the other hyper-inflated asset classes.”
How do you know it’s US investors, vs shady proxies buying in Luxembourg?
Here’s how we know:
In its last TIC statement (for November), the Treasury reported that $221 billion of Treasuries were held in Luxembourg. There are about $14.4 trillion of Treasuries held by the public globally (the rest are in US government funds, such as the Social Security Trust Fund). So only 1.5% of Treasuries held by the Public is held in Luxembourg.
But this is really what you’re asking: In total, foreign holdings, whether held in the US or in custodial accounts overseas, amount to $5.9 trillion. The remainder, $8.5 trillion, is held by the US public. 12 months earlier, the US public held $7.5 trillion. So that’s an increase of $1 trillion.
I probably should have supplied that detail in the article. It would have made more sense.
As foreign central banks cannot hold on their Treasuries, the FED plays now in my view a dangeruous game: the strong dollar policy. Reagan/Volker actually invented it in 1980, yet in the 90 ‘s also Greenspan/Clinton tried it successfully. The strong dollar policy is based on a strong yield differential towards major currencies (yen, euro, swiss franc…). This attracts capital from foreign countries (=hot money) searching for a yield advantage by funding it from a low yielding home currency (carry trade). This creates then an upward spiral in new investment and economic activity.
However, this policy has also its risk. It requires a fundamentally strong economy backed by a special economic growth phase (internet, PC, smart phone…). As Trichet tried the strong Euro policy in 2011, Germany could withstand it due to its exports, yet it was the final straw for Greece. Also Reagan and Greenspan had to backpedal in 1985 and 2002 and let the dollar plummet. Bush senior and junior were then left to clean up the mess when the economy was brought down by high inflation in 1988-1992 and 2006-2008.
If the US economy does not deliver over the next year we will likely see another steep drop in the USD followed by high inflation. The more it changes, the more it stays the same.
If you knew that Treasuries were going to negative yields, buying Treasuries now while everyone else is dumping them would be the greatest investment decision ever made. You can easily make 10-20-30 times your money once they go negative.
Partly it’s that China’s Treasury holdings had their maturity structure shortened?
Are the Elite buying up that debt and if so, we ought to be scared to death.