US Residents Shun Foreign Bonds while Foreigners Rush into US Corporates

By: Ashraf Laidi | Wed, Oct 19, 2005
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Net foreign capital flows into the US rose 4% to $91.3 billion in August from a revised $87.5 billion in July (initial reading was $87.4 bln). This was the fourth monthly consecutive increase in net foreign inflows for the first time since the data have been available in 1988. Equally positive for the US dollar is that the capital flows have comfortably exceeded the $59 billion trade deficit for the month.

The bulk of the continuous increase in foreign capital flows is largely related to corporate debt. US residents were net sellers of foreign bonds at $17 billion in August, the largest since the series were made available. That beat the previous record of $16 billion, which was during the LTCM crisis of October 1998 when US investors exited emerging market bonds. In contrast, foreigners increased their net purchases of US corporates by 62%. These two massive flows into US and out of foreign debt overshadowed significant declines of foreign flows in US stocks and agency bonds. (see below for reasons)

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FX Outlook

The dollar index is 10 points away from its 90.45 high of July 27 as the currency extends its gains ahead of what could be a fresh dosage of anti-inflation rhetoric from the Fed. Interestingly, however, Fed Chairman Greenspan's speech on energy in Japan today stipulated that higher energy prices would eventually lead to a slowdown in demand but more importantly stated for the first time that the rise in energy prices would have a drag on growth.

The market must watch in this week's flurry of Fed speeches whether any of the officials will begin including growth concerns along with the usual inflation worries. We have already seen Fed Board Governor Olson last week sticking to his "dissenter" view when he said he wasn't sure about whether price pressures were passing through while indicating that rising energy prices could restrain the economy "at least for a time".

While we stick with our month end forecasts of EURUSD at $118 and USDJPY at 112.00, we see the dollar's upward course beginning to fade in late Q4 when markets obtain better visibility as to when the Fed's rate hikes come to an end. Thus, although markets are currently pricing a 4.5% fed funds rate by end of January, the increased certainty that 4.5% will be the peak should help trigger unwinding of dollar longs - especially as the Bank of Japan sets to remove its accommodation in Q1 2006 and the ECB maintains its inflationary red flags. The dollar rise could even be sharply reversed in the event of a yuan revaluation against the dollar in the second half of the quarter, after the latest GDP figures.

In the meantime, we could see fresh dollar gains testing the preliminary support of $1.1872 and tomorrow in the event that the consensus forecast's 8-point increase in the October Philly Fed materializes.

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Ashraf Laidi

Author: Ashraf Laidi

Ashraf Laidi
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