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Yesterday the Treasury announced that capital flows into the US dropped to $56.6 billion in December after hitting $91.6 billion in November. Given that $56.6 billion is the weakest number in 7-months and was well below analyst estimates of $76.2 billion, you would think that the US dollar would have weakened following the report. After all, in December 2005 the US needed $2.11 billion every day to fund its trade deficit and it took in only $1.87 billion daily.
Ordinarily the dated TIC data does have an impact on the US dollar. However, yesterday was not an ordinary day. Rather, with Chairman Ben S. Bernanke’s slightly hawkish appearance traders overlooked the TIC data. It is also worth remembering that the December data could - and likely will given the ‘safe haven’ flows into Treasuries in January - prove to be a 1-month anomaly.
New Drivers of Demand
Japan actually reduced their Treasury Security holdings in 2005 by $4.9 billion and China only added $33.8 billion to their coffers. To give an idea of how unimportant China’s accumulation of $38.8 billion in Treasury Securities was in 2005 here is a collection of parties that bested that mark.
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Given that the UK and Caribbean Banking Centers are well known for being the launch pad for hedge funds, the 2005 data is a little alarming. To be sure, whereas central banks like Japan and China have economic/political agendas to guard – and selling US Treasuries could negatively impact these agendas - hedge funds are generally in it for the money. Point being, hedge funds could move out of US debt just as quickly as they moved in.
Dollar Demise Delayed
A basic yield comparison sees America as being considerably more attractive than most other places. Add to this the fact that the US continues to eye more interest rate hikes as other central banks grow hesitant and that the US economy is expected by most to continue to grow strongly and you have a recipe for continued US dollar strength.
With all these positives why be bearish on the USD? To begin with, it remains to be seen whether or not B.S.Bernanke will be good for the US dollar longer term. Mr. Bernanke said what the markets wanted to hear yesterday, but his intellectual focus has been on crashes, depressions, and deflation (which, to summarize Bernanke’s sentiments, are all supposedly preventable by printing money). Next, when yield spreads become less favorable and/or when US growth hits a wall the world will still have to absorb a flood of US debt. Any hesitation by the world to take on this debt would result in a weaker greenback and/or higher US interest rates. For that matter, if Japan and China say they are full and/or hedge funds opt to sell their Treasury securities and play somewhere else what you get is an immediate run on the dollar.
Suffice to say, with the US dollar seemingly stable and no immediate storm clouds on the horizon one indicator to keep an eye on is gold. While interest rates, inflation, and GDP forecasts are what guide the big money in search of liquidity through paper returns, gold represents the only currency currently capable of challenging America’s ‘safe haven’ status during times of crisis. It may not happen next month or even this year, but the US dollar succumbing to selling pressures is itself the crisis to watch for.
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