“Without question, the most important foreign buyer of US Treasuries decade to date has been China. Although Japan is a meaningful holder, it has been a much lesser force in supporting Treasury prices decade to date than has China. We’ve told you in the past that we believe UK numbers are in large part petro money floating through one of many global financial centers that is London. Secondly, London in part and the Caribbean in better part comprise hedge fund territory. The folks currently trying to front run the Fed? Maybe. As we’ve also discussed in the past, OPEC, Brazil and Russia have one very important characteristic in common with their main land Chinese brethren – they have been on the other side of the massive US trade deficit during the current decade that is now beginning to contract. Very important recipients of trade related US dollars that have so obligingly recycled those dollars back into US Treasuries, as well as US agency and corporate debt until recently (for very obvious reasons). Looking forward, two issues stand out as we question, “who’s the next buyer?” As we question how the US will fund itself in the wholesale global capital markets, if you will. The table above shows us directly how the US funded itself decade to date. How about looking ahead?
Simply stated, we believe the question of how and at what cost the US government funds its debt expansion ahead is quite the relevant watch point in 2009. China holds a very key seat at the decision-making and ultimate outcome table. Recent Treasury yields (or lack thereof) have already reached an extreme, and as such are unsustainable. Bernanke is on record stating the Fed will buy Treasury debt if need be. Clearly, whether he realizes this or not, the markets will hold him to that statement. In fact, this may become one of Bernanke and Company’s most meaningful “tests” in the year ahead. Choosing to inflate/reflate, the Fed cannot allow nominal Treasury yields to climb meaningfully, as such we believe the financial market relief valve by default will ultimately be the US dollar. The path appears very clear. It’s only the acceleration along the path that remains in question if you ask us.
Trading Places...As we mentioned above, we need to keep a sharp eye on China as we move ahead. You know we'll be monitoring their activities in terms of capital flows, especially their Treasury purchases. But this data comes to us with a multi-month lag. So as we look ahead, we need to be mindful of combining data anecdotes in trying to anticipate change in global capital flows. Again, the reason we've spent so much time on this topic in this discussion is that any meaningful change in global capital flows into Treasuries will hopefully allow us to time a point at which Fed Treasury monetization becomes a significant reality. We know they are already monetizing alternative assets such as mortgage backed securities, commercial paper, etc. But we simply cannot see how global debt and currency markets will not sit up and take meaningful notice when Treasury monetization begins.
We hope you've noticed recent "comments" being made in the Chinese press. A number of differing officials from a number of differing Chinese government departments have alluded to dollar weakness going forward. We suggest this is no coincidence. The Chinese are "telling us" this is what they expect. Like their US official brethren, the Chinese government is "encouraging" domestic banks to increase lending. And we know full well a Chinese stimulus package has already been delivered. Record US Treasury issuance is meeting up with a potential period of falling foreign demand for Treasuries, and we suggest China will be the key watch point in terms of this change in 2009.”
The following securities are ETFs that would be benefit in a dollar-weakening environment:
1. U.S Dollar Index Bearish Fund (UDN)
2. Short 20+ Treasury Bond (TBT).
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