FOREIGN $ INVESTORS ARE KEY / MACLEOD FINANCE

Foreign $ investors are key

There are signs that more realistic tariff policies are emerging. This should lead to a relief rally in US securities and take some short-term pressure off the dollar.

Alasdair Macleod

Clearly, the quiet exemption from Trump’s tariffs of electronic goods manufactured in China is excellent news and will lead to a rally in US tech stocks led by Apple when markets open tomorrow. 

Additionally, signs that Russian American negotiations over Ukraine are progressing out of the public eye illustrate that Trump may say one thing, but his officials are now finding ways to pursue more realistic policies.

But will this be enough to persuade foreign holders of US financial assets and dollars to stop selling?

The chart below graphically illustrates the problem:

Until two weeks ago, the yield on the treasury note correlated with the dollar’s trade weighted index. 

When one rose, the other did as well and they would decline together. 

Obviously, this reflected the consequences of changes in bond yields for marginal demand for the dollar. 

A higher yield attracted foreign buyers of both, while declining yields were less attractive.

After Trump’s “liberation day”, this changed. 

Bond yields which had been declining began to shoot up higher (the blue line) while the dollar sank. 

In fact, it threatened key levels just below 100 breaking below the August/September sell-off.

It is the clearest evidence of foreign liquidation.

This is why it was important for Trump to back down over tariffs. 

If he persists, the dollar will be overwhelmed by crisis and the Treasury unable to fund its deficit. 

This is why his Treasury officials must have threatened him with this reality. 

That he is now partially backing down should lead to a relief rally in the dollar, bonds, and equities. 

At the same time, a pause in the headlong rush into gold is on the cards.

However, big questions remain over the outlook for the dollar, interest rates, and bond yields after the short-term market responses. 

In large measure, this depends on changes in foreign dollar balances rather than domestic investor considerations. 

So, we should look at it from a foreigner’s viewpoint.

Trump’s vacillations over trade were tolerated until his liberation day announcement. 

It united economists of all persuasions in condemnation, pointing out the consequences for consumer price inflation at a time when the US economy already appeared to be stalling. 

The 90-day suspension was the first climbdown, but not enough to stop foreign dollar-selling.

The suspension was only temporary. 

The disruption to supply chains was still on and bound to send the US and global economy into recession. 

And it is the worst possible outcome for intensifying the Federal Government’s debt trap at a time of a falling purchasing power for the currency.

The increase in US M2money supply was only 4.3% in the year to February, which given the 6%+ stimulus of the budget deficit is evidence that credit available for the productive private sector is in decline. 

In other words, foreign portfolios are exposed to equities whose profits are sure to be downgraded.

Nearly all other major economies are similarly stagnating, which means that too many dollars are held for international trade purposes. 

And then there is the overall level of exposure to underlying financial assets. 

The most recent figures according to the US Treasury TIC figures show the breakdown of foreign investments in dollars as follows:

This total of nearly $40 trillion compares with US GDP of about $28 trillion. 

Foreigners are definitely overinvested in dollars on this basis, let alone for an economy with a subdued global economic outlook and whose government finances are in a mess.

This year, the US Treasury needs to roll over some $3 trillion of maturing debt and add a further $2 trillion to cover the deficit. 

Even if foreign investors just sit on their hands, it is likely to drive bond yields higher unless portfolio reallocations by domestic investors from equities to bonds make up the difference.

In the short-term, an equity bear market should lead to support for bonds, but probably at the short end of the yield curve. 

But that’s a one-off effect. 

Equally, it would cause foreign investors to sell equities, and they would likely sell some or all of their dollars raised.

Pressure on the dollar from equity positions being sold is bound to spill over into foreign holdings of US bonds because no one wants to take currency losses in a foreign currency. 

Furthermore, Trump is seen as a loose cannon by foreign investors so are unlikely to keep ploughing in additional funds to fund the budget deficit. 

Therefore, the rally we can expect from the climbdown on Chinese electronic goods is unlikely to go far before we return to bear market conditions, a falling dollar, and rising gold and silver values.