Bernanke Shields Dollar from Dismal Data

By: Ashraf Laidi | Thu, Feb 16, 2006
Print Email

Today's dollar rally was primarily driven by the Fed Chairman Bernanke's Congressional testimony, where he supported the FOMC's decision to deliver further tightening ahead. His speech reflected the FOMC policy statement on inflation expectations being well anchored despite energy fluctuations and on future policy actions being dependent on incoming data.

Bernanke shielded the dollar from the unexpected declines in industrial production and the sharp drop in foreign purchases of US treasuries. The fact that net capital flows fell below the trade deficit for the first time since April, would have been dollar negative had it nit been for today's highly anticipated testimony. The 0.2% decline in industrial production and the retreat in capacity utilization to 80.9%--both falling for the first time since September -- must be taken into consideration.

Net foreign capital flows into the US fell 38% to a 7-month low of $56.6 bln in December from a revised $91.6 bln in November (initial was $89.1 bln). The $56.6 bln was below the $65.7 billion record trade deficit for the corresponding month.


The 38% drop in December net foreign flows was largely due to the 66% decline in net purchases of Treasuries, which was caused by a 76% decline in non-official institutions' purchases (usually hedge funds) of US treasuries. The role of private institutions is especially essential considering that they accounted for 69% of the foreign purchases of Treasuries. The over-concentration of private flows into US assets raises the question of sustainability regarding the US financing of the US trade gap.



The plunge in private flows' holdings of US treasuries may be dismissed as an aberration stemming from end of year disposal and profit-taking, but the volatility nature of these flows must be born in mind especially when such flows have proven their size in offsetting the growing trade deficit, whose persistent i.e. nonvolatile growth is likely to pose challenges later this year -- especially if oil prices continue to push up the trade bill.

The 2005 trade deficit grew 17% to $726 bln, while net capital flows rose 14% to $1.05 trln. While foreign capital flows comfortably covered the trade imbalance, the risk of a continued rise in the trade deficit relative to lackluster growth in flows is highly realistic considering the fact that imports are more than twice exports and the increasing impact of high oil prices on US imports and the overall trade gap.

Corporate bonds and stocks help to fill the void of Treasuries and Agencies

The chart below shows that corporate bonds occupied the bulk of foreign interest in US assets, making up 42% of total net foreign flows in 2005, up from 34% and 37% in 2005 and 2004. This was crucial in offsetting the zero growth in purchases of treasury and Agency securities for the year. The 172% increase in net purchases of US stocks in 2005 was also essential in helping to broaden the USD-bound flows beyond over reliance on US treasuries as was the case in 2002-2004.

We may see a recovery in foreign interest in US treasuries following the reintroduction of 30-year bonds, which should trigger interest from central banks and most of all foreign asset managers and hedge funds. The increasing need for pension funds to hold longer duration in order to balance their long term obligations should also fill the void into government paper.



Ashraf Laidi

Author: Ashraf Laidi

Ashraf Laidi was created in January 1999 and is committed to enhancing public knowledge about the foreign exchange markets. The site offers the latest insights and analysis in currency markets, freely available to traders and researchers alike.

Forexnews.coms unique combination of fundamentals and technicals, along with its pioneering approach to the FX market, gives it the information edge. is the longest-standing on-line source of credible, timely and accurate information in FX world.

Forexnews.coms staff of analysts has gained recognition from highly placed media sources, both inside and outside of the US. Its analysts are regularly cited in Bloomberg TV, Reuters TV, The Wall Street Journal, Barrons, The Financial Times and Investors Business Daily.

Copyright © 2005-2006

All Images, XHTML Renderings, and Source Code Copyright ©