Before going any further, here is a report on the waning appetite of foreign Central Banks for US debt paper - Foreign Central Banks net sellers of US Treasury debt. Please read it.
Reuters published this report, which was taken from data compiled and reported by the US Fed, on Thursday, June 7. The report deals with foreign Central Bank holdings of US Treasury, Agency and corporate debt and is compiled on a weekly basis, the latest data as of the week ending June 6.
That day, June 6, was of course the day when the European Central Bank (ECB) announced an almost universally anticipated rate increase of 0.25 percent to 4.00 percent, the highest level in six years. On June 6, the Gold price in $US terms hardly moved, hovering just under the $US 670 level. The US Dollar Index (USDX) hardly moved either, falling 0.02 points to 81.84, its lowest level since May 15 and a mere 0.50 points above its low for the year - 80.25 set on April 25.
After that, and for the last two days of the week, all kinds of proverbial hell have broken loose on world financial markets.
The catalyst was a HUGE surge in the yield on Treasury debt paper. On June 7, the entire yield curve of Treasury notes and bonds (2 years and up maturity) bolted above the 5.0 percent level in the biggest jump seen in literally years. Treasury yields have been inexorably rising for more than a month now, but the LEAP on June 7 was of a different magnitude altogether. Please refer back to the link above, documenting the net selling of US debt paper by foreign Central Banks. The reaction on the US bond markets was instantaneous, and savage.
Even more savage was the repatriation of funds out of foreign markets and back to the US by American institutions and investors. Here's another article, this one from the Financial Times of London.: Risk-aversion gives dollar a lift.
Note the implication of the headline of this article, the only part of any article that most people read. The implication is clear - risk is growing all over the world so the US Dollar is rising as the "risk averse" flock to it.
That was the implication of the headline, but a paragraph in the body of the article showed clearly what was REALLY going on:
"Analysts said that in recent bouts of risk-aversion the dollar has tended to do well, as US investors who have been active in investing abroad either stopped or reversed some of those outflows."
In other words, every time there is a hiccup in US markets, US investors decide that they need more "liquidity" at home so they sell out of these investments "abroad" and repatriate the capital. This tendency becomes more acute when domesic interest rates are rising, as they certainly did with a vengeance on June 7, increasing the cost of borrowing in the domestic market. Of course, to actually use the capital freed up from their sales of overseas investments back home, US investors need to convert the proceeds to US Dollars. And in the process, the US Dollar rises, as it certainly did on the USDX on June 7-8.
Even worse, in this context, was the movement of the US Dollar against the Yen. One of the main sources of global "liquidity" in recent years has been the Yen "carry trade" - where investors borrow Yen at exceedingly low interest rates and then sell the Yen for other currencies to benefit from the MUCH higher rates available from paper denominated in these currencies. The problem here is that while the USDX was rising 0.85 points on June 7-8, it was actually FALLING against the Japanese Yen. This is a signal that the Yen carry trade is drying up. It is only a preliminary signal so far, but it it continues, one of the major sources of global liquidity is signalling that it is drying up too.
But all this is being ignored in US analyses now, the whole focus of which is to convince Americans that rising US interest rates are GOOD for the US Dollar. This has, of course, a surface plausibility. Higher interest rates mean a larger rate of return on US debt instruments. That must be good for the Dollar, right?
The superficial problem here is that right up until a month or so ago, the rampant US stock markets and the low rates on US Treasury debt paper were said to be in anticipation that the Fed would soon be able to start LOWERING official US rates again. But then US Treasury yields started rising - and rising - and foreign Central Banks just kept on raising their own rates. Over the past month, any hope inside the US that the Fed would start lowering rates has evaporated. Now, the "hope" is that the Fed won't have to start RAISING rates, and soon.
And just in case it DOES have to start raising rates, the ground is being prepared. The new mantra is that rising rates are good for the Dollar.
In fact, of course, the opposite is the case. Rising US Treasury yields are indicative of FALLING confidence in the US Dollar. They are rising because a RISK PREMIUM is being built into them, this risk premium reflecting the growing apprehension about the future purchasing power of the US Dollar. Every currency crisis, whenever and wherever it occurs, includes the twin spectacles of a rapidly FALLING currency riding along with rapidly RISING domestic rates. That was true of the Asian Crisis of the late 1990s. It was equally true in the US when the Dollar was plummeting in the early and late 1970s, the era of "stagflation" which more and more analysts are pointing at to explain what is currently going on.
The latest official data shows that foreign Central Bank holdings of US debt paper is actually FALLING. If this continues, the potential for foreign PRIVATE holders of US debt paper to start to sell increases dramatically. If that happens, the US Dollar spirals downwards and US rates spiral upwards. The past week has seen that "nightmare" scenario come a giant step closer.
Gold was sold off, partially for liquidity reasons, partly as a reaction to the new Wall Street mantra of a strong Dollar because of higher US rates, and partly to make sure that the rising fear of "inflation" world wide would not be confirmed. The selling was almost all in the US, and was of course done on the paper market by the US "funds".
The world is now said to be in the grip of a growing fear of "inflation". The actual fear is not of inflation, but of the growing likelihood that the monetary authorities will be forced to try to take sterner steps to combat it through continuing and possibly accelerating rate hikes. The acute fear - especially in the US - is that the Fed might have to join in, after holding the US Fed Funds rate unchanged at 5.25 percent for almost a year.
A last note. One of the most "respected" of all US financial institutions, JP Morgan, recently published a report which called for $US 1000 Gold "in the medium term". They did not define what they meant by the "medium term" in this context, but the very fact that they made the prediction is significant.
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