Are capital flows behind US$ weakness?
Investors today seem to be fixated on the process of the Federal Reserve and other central banks unwinding nearly nine years of Quantitative Easing (“QE”). Given the levels of consumer debt in some countries, they are understandably worrying whether interest rates can be risen and funding withdrawn from the system without dire consequences. The result has been a lot of talking and, so far, only hesitant action.
We would not deny the importance of this Quantitative Tightening (“QT”) but we think there is an elephant in the room which too many investors are ignoring. It is the Great Unwind, as investors from countries such as China and Russia, but also Europe, seek to repatriate money placed in funk-holes (mainly government bond markets in the US and Japan). As their economies recover from the shocks of the last five years, investors have - over the last twelve months - started to reverse these flows.
Our friends at CrossBorder Capital (the clue is in their name!) monitor these flows. They estimate US$3.5 trillion left China and the Eurozone since 2011, and that it is now flowing back fast. By comparison, Central Banks probably created around US$5.5 trillion of money above normal requirements since 2008 through QE and are expected to remove US$1-2 trillion of that over the next three to five years through QT. CrossBorder reckon twice that amount of capital flows could quit the US dollar and Treasuries over the same period.
What does this mean for markets? There is a bit of a two way pull at the moment for government bond markets and the US$, but capital flows explain the ‘weak’ US dollar and we would expect to see it continue to fall modestly while bond yields rise, perhaps more sharply. If you are interested, the full CrossBorder Capital article is available for purchase via the Liquidity tab on the left.