Escalation(s) TIC

According to the US Treasury Department’s Treasury International Capital (TIC) report, foreign private holders of UST’s had been selling them steadily in the last quarter of last year. Estimates including those just released for December 2017 show a total net reduction of $24 billion. While that’s not a huge number, private overseas interests typically buy more than they sell in any given period.

There are, and were, other factors to consider. To start with, it may have been related to the tax reform that President Trump signed finally in December. The likelihood of passage increased in the months before the final legal acts, meaning that by Q4 it was widely anticipated.

Part of the tax reform bill, now law, was changes to corporate taxation. As the President said at the Oval Office ceremony, “Corporations are literally going wild over this.” There is reason to suspect they may have been.

Foreign cash holdings of especially the largest US multinationals are stored largely in UST’s along with other assets already denominated in dollars, keeping some level of foreign reserves appropriate on a case by case basis. To begin using those assets in whatever fashion, including for many companies writing a large check to the US Treasury for taxes, it would necessarily require liquidating some reserve stock.

Just how much is unclear, as is the degree to which the process may have contributed to the bond selloff that gathered pace in the wake of passage. As a temporary issue, at some point this will pass, but since TIC is two months in arrears it might now show up for several months further into the future.

In the meantime, the rest of the data for December fills out the negative liquidity picture we chronicled given all the other events of that month. Specifically, for the second year in a row repo fails jumped to more than $800 billion (and were almost perfectly identical to level recorded in the same week in December 2016), alongside gold liquidation and a severe drop in the global FX basis (negative premiums for currency swaps that indicate “dollar” shortage) especially against euros.

The official sector is still “selling” UST’s as it has fairly regularly since the middle of 2014. The pace in Q4 was accelerated from Q3, though neither quarter was unduly harsh. That might propose overseas central banks constrained in their intervention or perhaps unaware of how quickly things progressed (particularly in the first two weeks of December).

Reported bank liabilities in dollars have reverted, apparently, to their prior pattern where the final month of each quarter draws down severely on outstanding balances. It had become a normal if curious feature of global eurodollar banking from before the “rising dollar”, as a loose proxy of bank balance sheet capacity, but then disappeared or was altered somewhere around Q3 or Q4 2016. The timing suggested perhaps “reflation” sentiment.

With Q3 2017 somewhat more like the prior regime rather than the “reflation” one, it remained for Q4 to fall on either side. With December’s update it clearly came in on “rising dollar.”

The decline in December wasn’t huge, but in relative terms compared to earlier last year it does seem to represent a negative shift in global dollar conditions.

That, of course, brings us to Japan. The Japanese during Q4 were “selling” UST’s at a pace we haven’t seen since just before the liquidations in January 2016. In the 4th quarter of 2015, according to TIC, the Japanese disposed of a net $54.6 billion. For Q4 2017, TIC shows a reduction of $34.5 billion.

JPY surged in later December 2015 and then kept on going for several months further. We already know, as noted yesterday, that in January 2018 JPY started to rise and now in February it has jumped recently to the highest level in a year and a quarter.

It appears quite likely that there is a limit either bureaucratic or ad hoc whereby Japanese officials cognizant of this drain on “reserves” cannot or will not allow them to accelerate. It is quite reminiscent of China’s (former) ticking clock regime. In January 2016, BoJ tried unsuccessfully to implement NIRP among other tricks in lieu of direct UST motivation.

Without what is very likely official assistance in collateral, JPY is forced higher as Japanese banks are, like Chinese banks were before, forced to pay premiums on FX.

It is a sort of liquidation event in this dimension of global money, and it in all likelihood has triggered and reinforced the others.

At $1.06 trillion, that’s the lowest reported level for Japanese UST holdings since 2011. It hasn’t been as dramatic as the roller coaster in Chinese holdings, but at -$180 billion from the high going back to November 2014 it has been substantial, and consistent with a global “dollar” environment that on its best days is spotty and uneven. It’s also in keeping with what I believe is the ultimate intent here, and what really matters as a baseline for a lot that’s going on particularly in Asia.

One reason that the eurodollar became more Asian in nature was perceived opportunity in China. As American and European banks struggled and retreated in the wake of the 2008 panic, understandably, Japanese banks saw an opening to step in as an even greater “dollar” redistribution point.

Even if swapping into “dollars” had become structurally more expensive post-crisis, there were still profits to be made given both that Japanese banks had growing yen liabilities at no cost (and also no yield) due to QE’s as well as connections in China via Japanese companies expanding in the country. This was the real carry trade.

Around 2012, it turned out that perhaps there was more risk in China than imagined, certainly more than Economists and the mainstream would ever admit to. By 2015, what had been merely less enthusiasm became more like an Asian “dollar” quagmire especially for Tokyo. China’s economy was at one time thought invulnerable and Japanese banks fully insulated by virtue of (wrong) how QE is always interpreted (money printing).

The “rising dollar” brutally exposed both fallacies.

What’s left is now what’s always left after eurodollar problems – all risk, no return. Because of that, I can’t see how Japan wouldn’t want out of this mess. It’s not that easy, however, like turning off a switch.

From China’s perspective, Hong Kong would have to become even more central to their ongoing “dollar” basis. Without Tokyo’s additional redistribution at the margins, what other choice beside the utterly destructive CNY DOWN did Chinese officials have? Better HKD mess than still on the mainland, I suppose, but for how long? Does JPY have an answer?

Too many questions, as usual, and beyond the capacity of TIC to respond comprehensively to them, especially as the data is always behind. Still, these estimates do help confirm what we have assumed had been the case, even if a lot remains missing. It makes it very hard to see how global inflation or economic acceleration is even possible let alone likely with what has been a constant drag and perhaps one that is now digging in again.