Rate Passions - Carry Trade Joins the Game

US Treasury registers the lowest inflow of foreign capital into US securities since 1993 level. There is an impression that the global dollar domination has been slowing down. In the best of times, 1.2 - 1.3 trn of foreign investments poured into the USA annually, and only 151.8 bln came last year.
Active sell-offs of the American dollar have been going for the second week - those are the results of impressions caused by weak macro economic data. The statistics on orders regarding long-term use commodities was the last straw - the whole 4% growth was caused by defense contracts without which the American economy, most likely, would have gone into a lengthy recession.

The current week saturated with American statistics and events can only add some negative. However, even if the current statistics do not encourage, any negative data today will create basic growth levels for the market tomorrow; and they certainly do not change anything for dollar in the long-term perspective. In terms of the dates of the first rate increase, September remains the most likely, so we still have time to assess the indirect influence of this possible event. Economists' logic assumes that Fed's rate increase will cause dollar growth. This opinion is supported, including, with the basic notion of carry trade transactions if they are used not only in a simplified form (for currency speculations), but as a banking instrument. Purchase of any asset in a foreign country requires conversion of its currency into the currency of the issuer of this asset - capital always flows towards higher rates. Rates on American bonds are quite higher today than those on European bonds; therefore, US bond are being purchased (both yield and reliability are higher).

Any Federal Treasury creditor will have to buy dollars (the same carry trade); however, an increase of base rates (theoretically) causes growth in all instruments, including loans. However, there is not even a hint at this in the Federal Reserve's comments. America has held low rates for quite a while, but, for instance, mortgage or consumer loan rates have gone down over the last years. There is a big doubt that they will also be raised in case of FRS rates growth, but they will certainly not go down since they are regulated through demand. If under present low rates people do not run for mortgage loans/credits that means that they can't afford that: either they don't have real income or their credit history has been compromised (experts estimate that 33% of Americans who took out loans can't pay them back). What happens if rates grow at least by 0.25%? Demand for loans will decrease, the market will try to regulate real rates, banks will resist to the end reducing the expected dollar growth to the lowest. So, we shouldn't expect dollar explosion, things will go gradually as FRS has promised. That is not quite good for the economy, in general.

As a confirmation: US Treasury registers the lowest inflow of foreign capital into US securities since 1993 level. There is an impression that the global dollar domination has been slowing down. In the best of times, 1.2 - 1.3 trn of foreign investments poured into the USA annually, and only 151.8 bln came last year. Two reasons for that can be seen:

  1. The main investor countries - Japan, China, Brazil, OPEC members, EU countries have serious problems with accumulation of financial resources either because of domestic crisis or due to the problems with current operation accounts. They are not in the condition to do that.
  2. The second reason is returning their foreign investments home by American residents (last year, they sold 14% more foreign assets than they bought). Despite the fact that the stocks of American companies have shown the highest growth in the last 15 years, there is no inflow of foreign investments into them.

Payments on US Treasury operations will be carried out this and next week, and there is a serious difference between distribution and repayment: On April 30, it is expected to obtain 123 bln dollars, and the repayment amount will be only 77.441 bln dollars. That is the biggest difference since last summer. That may be caused by the fact that dollar was sold for two previous weeks, while American stock market grew steadily. Such a large outflow of money can give dollar a small positive push; moreover, most of currencies (EUR, GBP, AUD, JPY) have already reached critical levels against USD, and further growth looks problematic. Monday brought low demand for dollar in the midst of reluctance to buy risks. EUR/USD took advantage of last week's expectations and bounced off 1.0900 due to the everlasting Greek problems. The Eurogroup meeting did not produce any results, and the perspectives are unclear. No pair growth is expected, level support being 1.0710 and 1.0660. GBP/USD left 1.5150/1.5200 resistance zone, but it has not defined its direction due to May 7 expectations. Ratings agency Fitch reduced Japan's credit rating from A+ to A; however, sales were not aggressive on that news.

Author: Navsher Bartash,
ForexChief Currency strategist