U.S. Treasuries slumped in September, as the 10-year Treasury yield breached 3.2% -- worrying investors that rates would shoot too high to a level that could cause equities to reassess their valuations. If yields rise as a result of economic growth, it is deemed positive for equities. However, any sudden or relentless move higher on the back of inflation worries or aggressive tightening financial conditions, equities take as a headwind -- and investors get worried. But there is something more sinister behind the move seen in U.S. bonds in September.
According to the latest published data, China and Japan dumped U.S. Treasuries the most in August. China reduced its holdings for the third straight month, and its holdings are off from the peak seen in 2017. Japan became a seller in August, with its holdings now at the lowest level since August 2011 and Saudi Arabia were buyers of U.S. debt in August. The broader trend has been clear in 2018. China, Japan and Russia are all sellers vs. Saudi Arabia as buyers. This has driven the global share of USD reserves to its lowest since 2013.
Russia's central bank has sold some $85 billion of its $150 billion holdings of U.S. assets from April through June, as the U.S. placed sanctions on its country and businesspeople. According to the recent data released by the International Monetary Fund (IMF), the percentage of U.S. national currency in the global central bank reserves declined to 62.3% in the second quarter, while holdings in the euro, yen and yuan gained as allocations changed.
Given the focus of U.S. foreign policy, it is no surprise to see these numbers -- nor the trends. The U.S. is alienating its trading partners and forcing them to tie up with others to re-establish their alliances. As there is a pickup in yuan trading in gold, oil, and metals, it is no surprise that Trump is hell bent on trying to cripple China as he fears their growth and regional dominance following the One-Belt-One-Road initiative.
Foreign policy aside, this has greater implications for the dollar than meets the eye. In the big-picture view, the world is moving away from the dollar. The wheels are in motion. What is supporting the dollar right now is that the U.S. central bank, with Fed Powell as its chair, has maintained a "gradual rate hike" interest rate policy path.
The data clearly warranted it all of this year and has led the rally in the USD vs. most developed market currencies. As the data gets softer and inflation stays contained, some argue that the Fed may be closer to its neutral rate than most think. Now that would surprise a lot of traders and economists if it were to be the case. The market is certainly very long the dollar right now.
Wednesday night, we have the FOMC minutes released from the U.S. Federal Reserve's latest policy meeting. The market waits eagerly to see if there are any hidden clues as to the timing and pace of future rate hikes. We all know President Trump is "angry" at the Fed, as they seem to derail his plan to nudge the stock market to all-time highs -- claiming "victory" and support going into U.S. mid-term elections. Since when do stock market gains imply a solid presidency?
Trump blaming the Fed raising rates too fast is the perfect alibi to have a scapegoat, if there were to be a collapse. Sure, there is no blame whatsoever applied to Trump's rash foreign policies, unnecessary and taxing trade wars and tariffs to coerce partners to give into the "Make America Great Again" way. Not to mention imposing sanctions on countries, limiting the free exchange of raw materials and goods, all of which is causing prices to spike -- leading to higher inflation, which in turn kills demand and growth.
Stepping away from playing the blame game, perhaps the Fed has the perfect excuse now as long-term consumer inflation expectations has been softening, and there are no signs "inflation is overheating."
Data has been decent, but is showing signs of softness as the demand collapse in the rest of the world feeds into the U.S. data, as well. The market has already priced in a rate hike for December, but any change in expectations for 2019 (more dovish wording) will be USD negative.
Everyone is positioned long, so this will come as a surprise -- but a pleasant surprise, as the market will rejoice in the "lower for longer" mantra and buy risk assets again. Forgetting the 40% correction in some emerging markets, even the U.S., following its 15% correction in quality stocks, looks mouth-watering. Watch the dollar, as it will be the key to the performance of all asset classes. Going into the FOMC minutes and subsequent Fed meetings, U.S. bonds look like an attractive risk-reward on the long side -- via the iShares 20+ Year Treasury Bond ETF (TLT) -- as the aggressive selling of the past month subsides.
