Economists and market analysts have pinned the dollar’s recent weakness on diminishing expectations for a Federal Reserve interest-rate hike by the end of 2016.
But some say there might be a more plausible explanation.
Marc Chandler, global head of currency strategy at Brown Brothers Harriman, said in a Tuesday note, that a rash of maturing Treasurys will leave foreign investors with billions in cash looking for a home. And given the rising cost of hedging dollar-denominated investments, they might not be as eager to reinvest that money in the U.S. Read the note here.
According to Chandler, $54.56 billion in U.S. Treasurys mature in August. The Treasury is also on the hook for $37.45 billion in coupon payments. All together, that is $92 billion in capital. New issuance of $62 billion will offset a big chunk of this—but that still leaves $30 billion to be invested. Chandler believes that a chunk of this is being repatriated or invested in higher-yielding bond markets. And Japanese investors, being the second-largest foreign holders of Treasurys after China, are likely to be key players, Chandler said.
From a purely technical standpoint, the dollar’s positioning looks vulnerable to Chandler. The ¥100 level might be the neckline to a head-and-shoulders pattern, and a break below that level—which happened early Tuesday—could signal more weakness ahead.
The theory that the dollar’s weakness is tied to expectations that the Federal Reserve might keep interest rates lower for longer has two important flaws, Chandler said. First, Fed-funds futures, a popular gauge of investors feelings about the timing of Fed rate increases, haven’t much substantially since the beginning of the month.
Presently, the odds cited by Bloomberg show an 18% chance of a hike in September, little changed from the probability expected on Aug. 1. The performance of the two-year Treasury yield, which is heavily influenced by rate-hike expectations, has fallen since the beginning of the month, suggesting that, if anything, the market sees a higher probability of rate increases.
Chandler isn’t the only one to hit on this theme. In a note released Tuesday, Capital Economics pointed out that the rising cost of hedging dollar-denominated debt has almost entirely eroded the yield advantage of U.S. Treasurys over Japanese government debt.
This problem isn’t limited to Japan.
“It is a similar story for euro-based investors looking to invest in Treasurys. The hedged yield available to them has also plummeted from more than 2.5% to around zero over the same period, not much more than the current yield of a 10-year German bund TMBMKDE-10Y, +0.00% ,” wrote John Higgins, chief markets economist at Capital Economics.
Falling foreign demand for Treasurys would also weigh on the dollar because if European and Japanese investors are buying fewer bonds, then they’re also buying fewer of the dollars needed to pay for those bonds.
To be sure, declining foreign demand isn’t a new trend. Treasury International Capital data released on Monday showed net selling of Treasurys by foreign investors for the third straight month in June.
Year to date, foreign investors have sold $143 billion of U.S. debt, the most on record in any six-month time frame, according to an analysis by The Lindsey Group.
“Bottom line, this wall of money that so many have thought has been piling into U.S. Treasurys in order to pick up some yield is not at all evident in this data and in fact, the exact opposite is happening,” said Peter Boockvar, chief market analyst at the Lindsey Group, in an email after the release.
However, the TIC data don’t cover the time period after the U.K.’s historic June 23 vote to exit the European Union, Boockvar noted, which means that they don’t explain recent moves in the dollar.
Some say the recent weakness in the dollar is largely a factor of the strengthening yen, as the belief that the Bank of Japan has little room to add to its monetary stimulus efforts has encouraged investors to keep buying the haven currency.
Quincy Krosby, market strategist at Prudential Financial, said in addition, the Japanese government “is just not there yet” in terms of implementing a promised ¥28 trillion ($274 billion) fiscal stimulus package. Without it, the yen is likely to continue finding support.
The dollar USDJPY, +0.33% has fallen nearly 2% against the yen over the past two weeks. In recent trade on Wednesday, one dollar bought ¥100.20, little-changed from Tuesday’s levels.