My Early July Surprise: More Outflows Of Foreign Money From U.S.
- Over the past several weeks, the yield on US Treasury securities have turned around and risen, a rise that seems to be connected with risk averse monies leaving the US.
- During the current economic recovery, risk averse funds flowed into the US and drove the yield on Treasury Inflation Protected securities down, some yields even dropping into negative territory.
- This flow turned around in November 2016 with the election of President Trump and has now begun to increase due to apparent change in direction of the European Central Bank.
I have been on vacation the past couple of weeks and so in catching up, I looked for what I considered to be the biggest change in the financial or economic data during this time period.
The first thing that caught my eye was the jump in the yield on the 10-year US Treasury note. In the middle of June, the 10-year rate was about 2.13 percent. On June 26, the note closed just under 2.14 percent.
On Monday, July 10, the yield on the 10-year note closed to yield around 2.37 percent, showing a 23 basis point increase from the late June date.
The first thing I looked for as an explanation of the big turnaround in the Treasury rate was an increase in inflationary expectations. Historically, if the 10-year Treasury yield jumps this much, the explanation usually is connected with some new economic data that causes market participants to look for more inflation in the future.
However, that was apparently not the reason for the jump in late June and early July.
On June 26, the inflationary expectations built into the yield of the 10-year Treasury note were only about 1.700 percent. On July 10, the same measure of inflationary expectations was around 1.742 percent; not much of a change.
Thus, I could rule out a rebound in inflationary expectations as the reason that the yield on the 10-year Treasury rose by as much as it did.
The next thing to turn to was the yield on the 10-year Treasury Inflation Protected Securities (TIPS).
Here, we find the source of the rise in the nominal interest rate. The yield on the 10-year TIPS was around 0.400 percent on June 26, and the yield on these securities was around 0.63 percent on July 10.
What seems to be the cause of this increase in the yield on the 10-year TIPS?
Well, the yield on the 10-year TIPS has, in the past, served as a proxy for the real rate of interest of the economy, a rate that has often been equated in the past with the expected real rate of growth in the economy.
In recent years, this connection between the yield on the 10-year TIPS and the expected real rate of growth of the economy has been broken. Over the past eight years, the US economy has grown at a compound rate of just over 2.0 percent per year.
During much of this time, the yield on the 10-year TIPS has been near zero and has only really climbed and remained above zero since last November.
However, a rate of 40 basis points or, even 63 basis points is not anywhere close to the expected rate of growth in the US economy over the next 10 years. Something else seems to be going on here.
Over the past several years, my research has indicated that the yield on the 10-year TIPS has been impacted by the international flow of funds into and out of the United States. I have written about this phenomenon for several years, now.
When risk-averse international monies become afraid of what is happening in other parts of the world and have significant confidence in the health and management of the US economy relative to the health and management of other countries, these funds have sought a safe-haven and have often flowed to the United States.
Tracking these flows over time, there seems to be a pretty close correlation between the flows of funds into the US and the fall in the yield on the 10-year US TIPS, even taking this yield into negative territory. When this happens, the correlations between the yield on the TIPS and the expected rate of growth in the economy decline close to zero.
In these cases, there appears to be little or no connection between the proxy for the real rate of interest, the yield on the 10-year TIPS, and the rate of growth of the US economy.
When confidence in the other parts of the world picks up relative to the confidence given the United States, the risk averse monies start to flow out of the US and back into other "havens."
Note that when this happens, the value of the US dollar weakens. And, this is exactly what has happened over the past couple of weeks. On June 22, it cost only $1.1150 to purchase one Euro. On July 10, one Euro cost $1.1400: a relatively strong drop in the value of the US dollar.
What seems to be the cause of this international movement of funds?
Well, the first reason seems to be that the European Central Bank appears to be near the end of its efforts at quantitative easing and is ready to begin raising its policy rate of interest. Thus, even though the Federal Reserve continues to raise its policy rate of interest and is apparently planning to begin to reduce the size of its balance sheet beginning some time this fall, the turnaround in the ECB's direction is producing the greater market impact.
In effect, the world central banks now seem to be moving in the same direction whereas over the past several years they had been moving in opposite directions.
But I think that there is an additional reason that the flow of funds is now heading out of the United States into other financial markets. In February, I wrote that the risk averse funds that had been placed in US financial markets over the past several years seemed to reverse their direction and began moving out of the United States after Donald Trump was elected as US President.
In March, I followed up on the earlier post and indicated how the huge amount of US debt outstanding in the world was at risk because of the movement of the "safe haven" funds out of the United States.
The current movement of funds also seems to coincide with the showing that Mr. Trump made at the recent G-20 meetings held in Germany. Or, as some have referred to the meetings as the G-19, with the United States going its own direction. Mr. Trump seems to be scaring these international investors, and so they are moving their monies into market that they deem to be safer.
And, from what I have recently seen, these two factors are not going to change in the near term. Central banks now seem to be headed in the same direction as far as where they intend to take their policy rates.
Furthermore, there seems to be a growing fissure between the world financial community and the United States causing international funds to leave the US and flow into other markets that are considered to be relatively safer now. It is unclear how this fissure can be bridged.
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