Phorgy Phynance

Flight to non-USD quality revisited

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Historically, sovereign reserves were (from my understanding) ultra conservative and consisted of mostly US treasuries. Increasingly, these sovereign reserves have been managed more actively and we are hearing more and more about the growth in sovereign wealth funds. When 40% of all US debt is held OUTSIDE the US, what is going to happen in a turning credit cycle?

On July 25, I stated my opinion on the subject in the post

Flight to non-USD quality

I also suspect that a “sovereign” flight to quality will not be a flight to US treasuries and in fact may be a flight away from US treasuries into EUR denominated government bonds. So as the credit market turns, the typical safe haven will not be available as even treasuries get whacked from sovereign sellers.

I may have been wrong about the EUR (or maybe I was right… time will tell), but it made sense to me then as it does now that sovereign wealth managers will not necessary flee to the “quality” of US treasuries as the credit cycle turns. In fact, it made sense to me then as it makes sense to me now that sovereign funds will turn their backs on US treasuries causing treasury yields to rise. This would hurt US investors who typically considered the US treasury to be safe during times of crisis.

Don’t get me wrong. It is not that I WANT bad things to happen. I am an optimist after all 😉 If I do manage to get one or two things right, rest assured I am not running around in glee with my t-shirt over my head.

Mostly, my comments on this blog are driven by two things. On the one hand, I am hoping to maximize my personal learning experience so that I will ultimately become a better investor. I expect to one day to have people put their faith in me with hard earned savings. I take that responsibility very seriously and want to be the best investor I can be. For both my own sake as well as those who place their trust in me. On the other hand, I hope that something I say may help others more experienced who currently are responsible for investing other people’s money to see things in a different light. I generally have unique or unorthodox ways of interpreting things and that has often benefited me as well as those who have worked with me. If something I say manages to generate a good investment idea, I will be happy.

With all that said, I found today’s BBG article to be very interesting.

Treasury Gain May Falter; Foreign Holders Flee Dollar

Treasury investors basking in the biggest rally in four years have reason to fear for their profits: The largest owners of U.S. government debt are heading for the exit.

[snip]

U.S. long-term interest rates would be about 90 basis points, or 0.90 percentage point, higher without foreign government and central bank buyers, according to a 2006 study for the Fed by Professors Francis and Veronica Warnock at the University of Virginia in Charlottesville.

[snip]

Government and central bank holdings of U.S. government debt at the Fed fell by $46.1 billion from the week ended July 25 to the week ended Sept. 5. They climbed to a record $1.25 trillion in July from $574 billion in June 2001.

[snip]

Asian central banks also reduced Treasuries last month in an effort to curb dollar gains against their currencies. Taiwan’s central bank cut its currency reserves by $4.9 billion in August, mostly by selling U.S. bonds, George Chou, a deputy governor of Central Bank of the Republic of China (Taiwan), said in an interview.

Even before the flurry of sales, more nations were starting to shift foreign-exchange reserves away from U.S. government bonds.

[snip]

China will likely, and appropriately, “reduce its holdings of dollar assets to get higher returns,” said Ha Jiming, chief economist in Beijing at China International Capital Corp., the nation’s largest securities firm. Ha attends central bank Governor Zhou Xiaochuan’s quarterly meeting with the nation’s lenders.

The $50 billion Qatar Investment Authority said on Sept. 4 it is looking for options in Asia to counter a weak dollar.

Makes perfect sense to me. A little common sense seems like it can go a long way these days.

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Written by Eric

September 9, 2007 at 9:49 pm

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