February was a very interesting month, wasn’t it? There was the pause or even end of the inflation hysteria driven home by “unexpected” liquidations in markets all over the world. On top of those, LIBOR-OIS blew out and all the absurd explanations put forth for it, and even outright lies. Needless to say (write), I’ve been waiting for the TIC update with a little more anticipation than usual.
The numbers for February 2018, released this week, did not disappoint.
To begin with, there was heavy buying, not selling, in UST’s among global central banks during that particular month. That is contrary to what we might expect in times like these; official accounts have tended to “sell UST’s” when global “dollar” funding conditions get too tricky. They were that two months ago.
We find buying in pretty much every locale, with one key exception (more on that below). Including China, most of the overseas official sector appears to have been behaving as if nothing much was going on. That may have actually contributed to the problem (liquidations), one that was amplified this time without the usual standby or backstop (selling UST’s).
The question is why. There aren’t any answers that jump out of this largely sterile data. It may be what usually happens during these periods (such as the second half of 2013 and the first half of 2014). Foreign central bankers are every bit susceptible to the global narrative as our own. Each “reflation” or upturn is looked upon as definitive. They undoubtedly believe there is “globally synchronized growth” and by the end of January it was reaching fever pitch.
If you buy into that idea, it’s likely that you fold up shop (“selling UST’s”) regardless of market conditions because you believe in the achievement of normality. No need to intervene in the “dollar short” any more, right?
There are other possible explanations, too, including possible collateral calls but there isn’t any way to sort that out with the limited data in TIC.
The one location where UST’s were not flowing was Japan. Oh, Japan. There is a whole lot going on over there, all of which reached a crescendo during February (JPY). Though the TIC data provides nothing more than a rough and limited proxy for eurodollar flows and conditions, there might be enough here anyway to pin the liquidations almost entirely on Japanese banks.
The series (two) presented above are what US banks report as claims (therefore US bank assets) on Japanese counterparties – including the bank sector, the non-bank sector, and the Bank of Japan (the FOI, or Foreign Official Institution). These estimates are like a barometer in a way, describing some of the visible activities in cross border dollar relationships. Thus, if there is downward trend to be found here we can reasonably assume (though not with any specific scale) that it is so all across the various transactions carried out in the modern eurodollar format (including footnote dollars that don’t get counted here or anywhere else).
As a rough narrative, therefore, what you see above is the emergence of the Asian “dollar” as a partial replacement for the prior European (and Caribbean) centered eurodollar system following 2008 and 2011. This would have been run through Tokyo as the main redistribution point, the real carry trade where Japanese banks already had/have more yen liabilities at no cost than they might ever use. What they did then was swap into “dollars” for redistribution elsewhere particularly China (gaining a higher yield and profits even factoring in the increased structural cost of funding “dollars” post-2008).
Starting in 2013, as questions about China’s economy and the financial (currency) risks thereabouts, these TIC figures suggest a scaling back of Japanese participation. There was still growth in the “dollar” trade, but a clear change in enthusiasm. It made sense given what took place at that time and then thereafter. In the immediate post-crisis period, the economy of the EM’s and particularly China was believed invulnerable. From 2013 forward, it increasingly appeared as if the Chinese would not be able to escape the global economic malaise, either.
The “rising dollar” period both in financial markets as well as the Chinese and global economy proved these risks valid, perhaps even underappreciated to a substantial degree despite everything that happened. In 2016, “dollar” funding costs grew especially prohibitive (record negative yen basis) leaving Japanese banks with the clear desire to run for the hills (high funding costs and greater risks in lending “dollars” is none but bad asymmetry).
These TIC US bank estimates suggest that starting around November 2016, they did just that (during the bond selloff, or BOND ROUT!!!) Now the Treasury Department reports that in January and February 2018, US bank claims on Japanese banks absolutely plummeted.
These estimates are subject to revisions, but the initial impression is an enormous $75 billion reduction in the first two months of this year – the very moment these liquidations appeared out of nowhere (not really out of nowhere, but you get the point). There is clearly seasonality to all this (Golden Week again?), but by way of comparison in the first two months of 2017 the decline was “only” $20 billion.
This is by no means dispositive, but it does emphatically draw our attention toward Japan for what’s been going on. Again, the lack of central bank backstop alongside this withdrawal, especially in Asian markets, could help explain this:
That’s not all, however. The other big thing going on in Asia at the moment is HKD. The mainstream view is that the falling Hong Kong dollar is either safety flows reversing (global “capital” that starting in 2008 sought out the relative calm of Hong Kong and its stable markets) as the global recovery progresses, or, relatedly, it’s the old interest rate differential game where higher money rates particularly in US$’s is drawing out flows away from very low yielding HKD money markets.
My view is very different. Instead, given the almost perfectly mirror-like behavior between CNY and HKD it seems more likely (to me) that Hong Kong banks have been pressed into “dollar” service on behalf of Chinese banks. These latter in eurodollar markets, as noted above, are almost certainly being abjured (charged too much premium) for the greater perceived risks involved (especially with Japan on the retreat from this business). Thus, HK banks borrow the eurodollars at better rates and then some (creative) backdoor channels are opened to funnel them further into the mainland.
If that’s the case, then we should expect to find a substantial enough increase in our proxies for “dollar” activity represented by TIC:
It’s not nearly the scale of Japan going in the other direction, but we would never expect it to be. According to TIC, US bank claims on HK banks payable in US$’s surged by $7 billion in December 2017 and by another $7 billion in February 2018 (pause in January). That’s a 31% increase in those two months just prior to the big drop in HKD, and CNY starting what has become yet another sideways trend.
It’s possible that is nothing more than investors trying to take advantage of interest rate differentials, but then again they didn’t change all that much during those particular months. What really did change? Global funding conditions out of Tokyo, therefore Asian “dollar” issues, and thus a likely increase in pressure on China and therefore HK’s backdoor supply capacity.
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