Asset Prices, Leverage and Portfolio Rebalancing ...
... Global Capital Flows Cycle -FRB Dallas
I continue to believe in the ‘Japanification’ of markets and central planning. I **HOPE** I’m wrong and that USTs never ‘trade by appointment’ the way in which its said JGBs do BUT with that in mind, I do find this note from Dallas Fed to be interesting (and concerning).
Given our current bout of risk off, F2Q buying of bonds, I thought worth a mention. It begins with,
Over the course of a global financial cycle, the prevalence of leverage—among investors and across nations—can explain fluctuations in gross and net capital flows, portfolio modeling shows. The amount of leverage—borrowed funds relative to the value of underlying assets—increases for risky holdings during downturns, motivating their ultimate sale to achieve a more secure financial position. The opposite occurs during upswings, as risky assets gain favor.
Sounds pretty benign. Basic. The Dallas Fed economists continue with,
… Net Safe and Risky Asset Flows in Early 2000s
The U.S. and Japan between 2002 and 2009 provide a useful example.
Our work suggests that this global financial cycle reached a bottom in 2002, peaked in 2007 and then bottomed again in 2009. In 2002, the U.S. held a net foreign-asset position in safe assets of -23 percent of GDP, and Japan had a net foreign-asset position in safe assets of +33 percent of GDP. Chart 3 plots the net outflows in safe assets in the U.S. and Japan in 2002, 2007 and 2009.
AND Dallas Fed economists conclude,
… The movements in net flows in safe and risky assets reflect the desire of U.S. investors to rebalance to preferred levels of leverage by taking on more debt to buy more risky assets. Japanese investors do the opposite since the increase in global risky asset prices raises their portfolio share in risky assets.
This entire process went into reverse during a downturn in the global financial cycle and the fall in world asset prices between 2007 and 2009, where U.S. net outflows in safe assets increased and net outflows in risky assets fell.
Will there be a day that USA ‘does the opposite’ and risk ON/off is in markets beyond USDs reach?