Introduction – The death of the US dollar as the world’s predominant reserve currency has been long debated and predicted. In this article, I explain some of the recent trends and events in the US Treasury market and refute the case for the death of the dollar.
Assertion: The dollar is still the dominant currency of the world. And it leads any other currency by a huge margin!
- But haven’t there been lots of episodes of volatility is the so-called safe US Treasury market? Yes, but there are reasons behind those episodes and the causes are being addressed through policy changes and improvements.
- Haven’t foreign central banks and private investors been selling US Treasuries? Yes, but there isn’t a major reduction in the amount of US Treasuries held by foreign central banks and private investors.
- Has demand held up well in recent treasury auctions? Yes, bid-to-cover ratios and allocations to foreign investors have broadly remained stable in treasury auctions.
- The dollar’s share of official foreign exchange reserves
- The dollar still is by far, the most dominant currency in global foreign exchange reserves (59.5%)
- The US dollar’s share has reduced from approximately 70% in 2000. But it is still the largest by a huge margin. The RMB constitutes just 2.5%.
2. Foreign investors share of USD paper bank notes
- Value of U.S. dollar banknotes held abroad has increased over the past two decades (approx. 45% now). Estimated to be over $950 billion.
- The dollar’s usage as an anchor currency has increased over the past two decades. It is estimated that 50% of world GDP in 2015 was produced in countries whose currency is anchored to the U.S. dollar (not counting the United States itself). In contrast, the share of world GDP anchored to the euro was only 5% (not counting the euro area itself). (Source: Federal Reserve)
3. US Dollar share of global export financing
- I love this chart. Displays very well how the USD is the dominant transacting currency in international trade. People and companies sell their goods and services cross border primarily in US dollars.
- Over the period 1999-2019, the dollar accounted for 96% of trade invoicing in the Americas, 74% in the Asia-Pacific region, and 79% in the rest of the world. The Euro is understandingly dominant in Europe.
4. But haven’t there been lots of episodes of volatility is the so-called safe US Treasury market?
- Foreign investors, including central banks and monetary institutions, rapidly offloaded US treasuries during past episodes of crisis / panic
- From March to May 2020 Foreign investors sold roughly 400bn of treasuries. Once the sell-off had subsided, foreign investors were back to buying treasuries.
- Like I have explained in multiple videos and articles, global crises are often simply dollar shortage events. At the slightest sign of major economic trouble, central banks, corporations, individuals around the world start hoarding dollars which further exacerbates the shortage. The fire sale of US Treasuries in March 2020 (long dated bonds in particular) was a similar dash for cash. To shore up liquidity for the proverbial rainy day that had arrived.
- The above graph shows that Central Banks sold US Treasuries to shore up dollars in previous crisis as well.
- The GFC was an exception. Foreign Central Banks and Foreign Private Investors were net purchasers of US Treasuries during the peak months of the GFC. There were multiple reasons for this, one of which was that Saudi Arabia and UAE were net purchasers of US Treasuries in the GFC event with the substantial current account surpluses they were generating on account of high oil prices in 2006-2008.
- The Fed also set up a permanent repo facility in 2021 for foreign central banks (FIMA Facility). This standing facility allows foreign central banks with accounts at the NY Fed to draw on US dollars in exchange for the treasuries that they own. This significantly reduces the need for selling these treasuries during times of crisis and foreign central banks can instead just choose to repo them.
5. Haven’t foreign central banks and monetary institutions and private investors been selling US Treasuries?
- Foreign investors continue to hold a sizeable chunk of outstanding marketable US treasury securities. Approximately US$7.5 trillion or about 33%.
- A large portion of the above charted holdings of US Treasuries are Foreign Central Banks and Monetary Institutions
6. Has demand held up well in recent treasury auctions?
- Percentage of net issuance of US Treasury bonds absorbed by foreign investors has remained pretty much the same over the last 5 years. Infact, based on the last Treasury department report it has inched up in the last quarter of calendar 2021 with rising US yields.
- Bid to Cover ratios for long dated US Treasuries have remained fairly stable as well
7. So is it an all clear for the road ahead for Treasuries. Not at all. Still have to watch for –
- The 40 year bull run in fixed income has been delivered a crushing blow by the 40 year high inflation rate. Rising rates translate to falling prices and investors will be generally extra cautious of fixed income instruments.
- The stall in foreign demand is unmistakably present. We saw a similar episode of softer foreign demand in 2018 as well. Hence it is worth keeping a tab on this data
- Hedging costs might potentially increase significantly, especially foy JPY investors (which still form a large portion of foreign demand)
- And last, but most important, no one really knows for sure what will be the impact of QT on money markets and funding markets. The last time QT ended with an explosion in the repo market (Sep 2019). The next stress event will once again influence and shape this cornerstone of the global financial system
To know more about the Federal Reserve and US Monetary Policy, take our Fed Demystified course and watch the videos at the link below!
Disclaimer and Disclosure: Not meant to be investing advice ! Do your own research!