It wasn't supposed to be this way. When the Federal Reserve hiked benchmark rates in December, the initial jump in the short-end of the nominal U.S. yield curve raised expectations that foreign buyers would snap up the country's assets, thanks to their yield relative to those of other developed markets ravaged by low policy rates. In fact, net foreign flows to the U.S. have been decidedly weak this year, thanks to an exodus by foreign central banks and sovereign wealth funds, who've been dumping U.S. securities in order to raise cash to put to work at home.
In May, official institutions abroad raced out of U.S. stocks and bonds with $26 billion of outflows. Private buyers abroad were, by contrast, net buyers of U.S. securities, but that wasn't enough to keep the total positive: foreign flows out of U.S. securities totaled $11 billion, according to the most recently available data in May, sharply reversing April's $80.4 billion of inflows.
Don't let April's high number fool you: the historic significance of this weak flow story is laid bare by analysts at Ned Davis Research Inc., led by Joseph F. Kalish, in a research report published Thursday. Looked at on a rolling 12-month basis, inflows to the U.S. from foreign investors fell to $47.2 billion as of May, which is the second-lowest reading since the same month of 1992, the analysts say.
Even though U.S. monetary conditions have belied December's rate hike by loosening this year, amid market expectations that further tightening isn't coming any time soon, the reason for foreign flight has less to do with Janet Yellen than conditions back home. Official institutions overseas — led by central banks and sovereign wealth funds in China and the Middle East — have been dumping U.S. Treasuries and stocks over the past year to support their currencies and stem capital outflows.
"Treasury sales by official investors reflect the big fall in Chinese reserves, and the ongoing need by some oil exporters to sell assets, such as Saudi Arabia," according to Brad Setser, a senior fellow at the Council on Foreign Relations in New York.
Correlate non-U.S. economies' balance-of-payments data with this Treasury International Capital data (the U.S. government's monthly report on foreign flows), he says, and the trend takes on another dimension: "Official sales are actually bigger in my view than the number in the TIC data, as some official sales show up as private sales. "
The Chinese official sector sold almost $100 billion of U.S. stocks over the past year, Setser reckons. Rather than purchasing U.S. bonds, its private sector has been busy repaying external bank debt, building up offshore U.S. dollar deposits, and buying life insurance policies in Hong Kong — among other things.The higher U.S. yields (at least relative to other developed countries) that were supposed to lure foreign investors have led to a home bias among Americans, and generated a healthy demand among foreign private investors, from the euro area to Japan. That's especially the case for U.S. corporate bonds. This has helped to depress nominal corporate yields, despite the exodus of Chinese and Middle Eastern official-sector investors.
"In a world where the big current-account surpluses are in China, Korea, Japan, the euro zone, Switzerland and northern Europe, low yields there are driving private investors into higher-yielding U.S. bonds, with a tilt, it seems to U.S. agency debt, and toward corporate debt for more of a yield pickup," Setser says.
If emerging-market economies stabilize, and foreign central banks refrain from selling their Treasuries, U.S. yields would fall given the increase in net demand, other things being equal, the Ned Davis Research analysts conclude.