"Foreign demand for any US bond with a smidgen of credit risk has disappeared."

Brad Setser with a continuing theme, the flight from risk:

"This is an example of what Calculated Risk calls cliff-diving. Foreign demand for any US bond with a smidgen of credit risk has disappeared. Indeed, the fall in demand for Agencies over the past three months is more severe than the fall in demand for US corporate bonds (think securitized subprime mortgages and other securitized housing and consumer debt) last August.

Normally, this kind of fall-off in foreign demand would be associated not just with a credit crisis but also with a currency crisis. A country cannot finance a trade and current account deficit without financing, and two big sources of financing for the US deficit — foreign purchases of Agencies and US corporate bonds — has disappeared. The US, though, isn’t a normal country. The fall in demand for risky US assets was offset by a rise in demand for Treasuries and the sale of foreign assets by Americans."

1)Trade & Current Account Deficit needs FINANCING
2) FINANCING from Foreign Purchases of AGENCIES & US CORPORATE BONDS
3) Without FINANCING = Credit & Currency Crisis
4) FINANCING ( now ) from Foreign Purchases of TREASURIES & FOREIGN ASSETS

"This data clearly shows a massive shift from Treasuries to Agencies.

To complete the picture I added short-term t-bill purchases by private investors to the long-term purchases and short-term official purchases. Total Treasury purchases over the last 3 months totaled $214 billion. That’s huge."

I think it's from AGENCIES to TREASURIES:

"Combining that inflow with $92 billion in net sales of foreign assets by American investors implies that the “flight to Treasuries” and “deleveraging” combined to provide about $300 billion in net financing to the US. That, in broad terms, allowed the US to run a roughly $175-200b current account deficit and cover a huge outflow from the Agency market.

China is particularly interesting case. SAFE clearly has added to the instability in the credit market over the past few months — and equally clearly contributed to low Treasury yields. That isn’t a criticism — it is just a statement of fact."

Low TREASURY Yields from high demand:

"At the end of July, China stopped buying Agencies and corporate bonds and started to pile into Treasuries. Over the last three months of data (i.e. the third quarter), the US data indicates that China has bought $81.1 billion in Treasuries ($45 billion short-term) and added $17.4 billion to its bank accounts — that is a flow of nearly $100 billion into the safest US assets China can find. Conversely, China sold $16 billion of Agencies, $1.8 billion of corporate bonds and a bit less than a billion of equity."

See this post.

"The September data also should put to rest all the talk about China retreating from Treasuries. The real issue is that China has retreated from the Agency market. True, September is a long time ago — but the Fed’s custodial data doesn’t suggest anything has changed since then.*

I’ll conclude by looking at trends over a somewhat longer time horizon. Starting last August, foreign demand for most kinds of risky US assets dipped. There is a clear break in a chart showing rolling 12m purchases of corporate bonds and equities back then. More recently, Agencies got reclassified as a risk asset. There was a bit of a fall off in demand for Agencies last August — but the really big fall off has come recently.

So the flight from risk started in August. Right now foreigners don’t seem to be interested in any kind of risky US asset.

Instead they are buying Treasuries.

And remember this is just a chart showing foreign purchases of long-term Treasuries. In addition to buying roughly $385 billion in long-term Treasuries, foreign investors snapped up another $240 billion (gulp) in short-term Treasuries. That works out to a net inflow in the Treasury market of over $600 billion …

Of course, Treasuries aren’t entirely risk free. I don’t believe that there is a real risk the Treasury would default. Buying credit-default swap protection on the US is something by colleague Paul Swartz calls an end-of-the-world trade. But foreign investors holding long-term Treasuries are clearly taking a lot of currency risk — especially if they are buying in now, after the dollar has rallied …

The US is taking a risk too. The rising stock of short-term bills held abroad does potentially leave the US more exposed to a rollover crisis."

They're buying now when the DOLLAR IS HIGH.

I'll say this again. I can understand the flight from risk.

NB: This Post:

"The plunging euro

Why is the euro plunging against the dollar and the yen? Why are European banks coming under renewed pressure? Should the emerging financial and foreign exchange crisis of countries gravitating around the euro lead to new EU policy instruments?

The euro is plunging against the dollar because investors, in their scramble for safety and liquidity, are flocking to US and, also to some extent, Japanese government bonds which are considered safer and more liquid than other government-backed paper available in the market – including public debt instruments issued by European governments. In other words, the constellation of separate markets for sovereign debt paper of unequal quality issued by European governments cannot compete with the US market for the huge global financial flows in search of a safe harbour."

And this post:

Saturday, October 25, 2008

``Any sense of rationality and fundamentals is thrown out the window.''

Bloomberg on the flight to safety, with the emphasis on flight:

"Dollar Gains Most Since 1992 on Concern Global Slump Deepening

By Ye Xie

Oct. 25 (Bloomberg) -- The dollar gained the most in 16 years against the currencies of six major U.S. trading partners as a global economic slowdown spurred demand for the greenback as a haven from losses in emerging markets.

``The foreign-exchange market is basically saying we are in a global recession and perhaps a very, very deep one,'' Richard Franulovich, a senior currency strategist at Westpac Banking Corp. in New York, said in an interview on Bloomberg Radio. ``Any sense of rationality and fundamentals is thrown out the window.''

I'm going to start collecting quotes saying that fundamentals are being ignored, as well as quotes showing that investors consider government intervention.

And this post:

Saturday, October 25, 2008

" Investors around the world fled stocks and rushed to the relative safety of the U.S. dollar"

The effects of the crisis are spreading. See this post in the Washington Post:

"Gloom about economic growth translated to low expectations for oil consumption. The Organization of the Petroleum Exporting Countries yesterday announced a cut of 1.5 million barrels a day in output -- a move that still failed to arrest the slide in crude prices. Meanwhile, copper prices fell to a three-year low.

Investors around the world fled stocks and rushed to the relative safety of the U.S. dollar by pouring money into 30-year Treasury bonds, a refuge in times of uncertainty. That drove down the value of foreign currencies, from the ruble to the rupee and the zloty to the peso, forcing central banks to spend billions of dollars to prevent even further deterioration. The turmoil in currency markets threatened to reorder trade relations and complicate recovery efforts."