May 2017 U.S. TIC Purchases $57.3B Equals Dollar Support

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Includes: BZF, DEE, DRN, FXA, IWD, IWS, REM, REZ, ROOF, SPY, UUP, XHB
by: Alan Longbon

Summary

As demand for U.S. financial instruments increases, the value of the dollar rises.

Demand for TIC is higher last month pointing to dollar support.

A positive result lends support for the dollar and a change of trend.

Most people would ask what is TIC?

TIC is "Treasury International Capital."

"TIC is a select group of capital monitored with regard to its international movement. Treasury International Capital is a useful economic indicator that tracks the flow of Treasury and agency securities as well as corporate bonds and equities into and out of the United States. TIC data is important to investors, especially with the increasing amount of foreign participation in the U.S. financial markets."

(Source: Investopedia)

So what does it mean when TIC moves up or down?

As demand for U.S. financial instruments increases, the value of the dollar is held up. Demand for U.S. dollar increases as it is needed to purchase U.S. securities.

TIC has increased for four months in a row. The amounts were small and the dollar did not rise in that time.

Purchases of $100B plus per month are needed to move the dollar upwards in larger steps. These size purchases were occurring at the end of last year. This last quarter we have seen weak to negative TIC purchases and weakness in the dollar.

The charts below show the monthly movement of TIC with the addition of the May 2017 figures.


Net Treasury International Capital Flows includes all net foreign acquisitions of long-term securities, short-term U.S. securities, and banking flows.

The net TIC flows are much larger in May than they were in April and this is a good sign for dollar strength.

So why is this important now?

In a report, the Department of the Treasury said that U.S. net TIC purchases rose to a seasonally adjusted $57.3.8B after buying an upwardly revised $74.4B in April.

The increase in TIC represents stronger underlying demand for the U.S. dollar going forward. That said the dollar had gained strength in the lead up to and also in the weeks after the election and has lost some of that gain and is finding support around the $94 dollar mark.

I find that large changes ($100B+) in TIC give a one month's advanced warning of a movement in the dollar. The latest change is a larger and more positive move than has occurred for many months and builds on previous months positive flows. The changes in TIC late last year were much larger and led to larger dollar gains, however ever the gains over the last two months are getting into a magnitude that can move the needle.

One can expect to see the dollar remain at its present level for another month going forward and might even gain a little ground. A chart of dollar future movements is shown below.

The dollar is approaching the low set in early 2016 and will most likely find support there. The next line of support, should that fail, are the tops set in 2009 and 2010 at 87-88.

The very long term the TIC picture is not as decisive as it once was as the chart below shows.

Prior to the 2009 GFC boom-bust, TIC was a one-sided affair with net inflows of capital into America. The situation since then is more balanced with matching in and out flows and no strong trend in either direction.

Most commodities trade in US dollars so they are needed to effect transactions even for transactions not involving the USA. The effect of the USD being the world's reserve currency. The dollar has fallen lately and so more dollars are required when a foreign country seeks to exchange its currency for USD.

Strengthening world trade and world GDP means strengthening TIC flows and USD. The chart below shows the steady march of world GDP upwards. GDP is the sum of all transactions that take place in a year if more transactions take place using USDs that makes the demand for USDs greater and their value goes up.

The backing behind the USD also gives it value. The USD is a fiat currency issued by the US government and the US government is a currency sovereign. The backing behind the US dollar is the land, labor and capital that generate goods and services that people want to buy. A currency can rise as a result of a growing GDP, increased capacity utilization and labor employment. At present, the US economy has all three of these features and is yet another reason for the value of the dollar to rise, quite apart from its role as the world reserve currency.

The demand for imports also causes a currency to rise as a function of more dollars being required overseas to pay for imported goods.

The USA is a net importer and would prefer a strong currency so that it can buy those imports cheaply and so a strong dollar is good for the USA.

(Source World Economics)

The chart below shows the parabolic growth of world trade upwards. The impact of the GFC on world trade is unmistakable as is the long term trend.

The chart below shows the longer term dollar trend.

Since 1970, the dollar appears to move between a value of 80 to 160 and appears to be trending towards another long term cyclical peak such as was made in 1985 and 2001.

A country's currency strength is like a share in a company. When the company is doing well by using all its capacity, making sales and growing, its shares increase in value as its asset backing and earnings increase. The same is true for a nation state. The currency tends to bottom when GDP is falling and unemployment is low and top when the opposite is true.

America reached the bottom of the GFC boom-bust in 2010 and has been growing ever since. The same is true of the value of the dollar. Higher GDP and higher employment gives the dollar asset backing and earnings and pushes its value higher relative to other world currencies.

As the economy improves and there are more jobs and income the demand for imports rises and this creates overseas demand for the USD and pushes its value up.

So how can this trend help me?

The most obvious benefits of this trend for investors and traders are as follows:

  1. REITs will suffer from higher interest rates. When interest rates go up, borrowing costs increase and asset prices go down from the reduced capacity to pay higher prices for them. (NYSEARCA: DRN), (NYSEARCA: REZ), (NYSEARCA: REM), (NYSEARCA: ROOF), (NYSEARCA: XHB). On the flip side when rates go up so do rents which tend to maintain yields and margins making REITs a safe bet in almost any investing environment.
  2. Commodities will decrease as most trade in U.S. dollars. Short commodities (NYSEARCA: DEE).
  3. Other currencies, particularly those from commodity-based countries like Russia, Australia and Brazil, will fall, so short these. (NYSEARCA: FXA) (NYSEARCA: BZF).
  4. U.S. companies with substantial overseas earnings will make less in U.S. dollar terms. This will disproportionately affect the S&P 500 as this index is overweight with mega cap export earning companies. I would stay long the S&P 500 (NYSEARCA: SPY) for other reasons not linked to the dollar. Stay the course.
  5. On the other hand, mid-cap U.S. companies with domestic earnings will be largely unaffected but will have to pay less for their import of goods and materials. (NYSEARCA: IWD) (NYSEARCA: IWS) Stay the course.
  6. I see this TIC result as a build up to another upward move in a longer trend upwards and would stay the course for the time being in investments that are geared for an ever stronger dollar. Long the dollar (NYSEARCA: UUP).

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

Additional disclosure: I have dollars.