US dollar remains vulnerable to downside after downgrade

USD: Moodys follows eventually with downgrade

The US dollar is softer and longer-term yields are higher with the S&P future down 1.0% suggesting the potential for a day of triple selling of US assets that is being driven by the decision of Moodys to downgrade the sovereign rating of the US from the top Aaa rating to Aa1. The downgrade was coming and Moodys was the last of the big three to lower the sovereign rating of the US from the top level. S&P did it first back in 2011 followed by Fitch in 2023. Moodys had recently provided an update on its position of the US that signalled a downgrade was coming.  

Moodys cited “the increase over more than a decade in government debt and interest payment ratios to levels that are significantly higher than similarly rated sovereigns”. It also added that it did not believe multi-year reductions in deficits were likely from current fiscal proposals under consideration. The downgrade came just before a deal over the weekend that resulted in the House Budget Committee approving President Trump’s tax and spending package. The deal was reached following agreement with Republican hardliners for quicker cuts to Medicaid health coverage and a faster phase-out of clean energy tax breaks and subsidies. Challenges remain and further changes to the bill seems likely with Senate opposition to elements of the bill likely to be the biggest issue ahead. The Moodys downgrade will further reinforce fiscal hawks of the needs to offer a credible, achievable bill.

This downgrade, while the final one from the big three ratings agencies could well prove the most significant. Episode of triple selling of US assets have been few and far between in recent years. Our analysis of these episodes (with 30yr yield at least 15bps higher) tend to point to further US dollar selling ahead. The episode in April on such a scale was the first since 2001. The current bill agreed in the House over the weekend, even assuming it is toned down, will ensure the US continues to run deficits much higher than in other major developed economies and in the region of between 5%-7% of GDP. That will considerably increase the risk of counter-productive moves higher in yields that ultimately crowds out the growth benefit. The main cost of the bill remains extending the current tax cuts and is therefore more about avoiding a big tax hike that hits growth than providing a boost to growth.

We published a new trade idea of short USD/JPY on Friday that was of course prior to the Moodys’ downgrade. Risk aversion is higher now than expected with Asian equities mostly lower. A steeper yield curve in the US and continued questions over confidence in US assets will reinforce downside momentum in USD/JPY. BoJ Deputy Governor Uchida repeated again today the intention of the BoJ to hike the policy rate if the BoJ’s economic outlook is realised.

30YR UST BOND YIELD CORRELATION WITH THE US DOLLAR HAS TURNED NEGATIVE

Source: Bloomberg, Macrobond & MUFG GMR

USD: Flow data indicated little evidence of sell US in March

In our FX Weekly on Friday (here) we highlighted the fact that while there has been evidence of central bank selling of UST bonds both in recent months and further back over a number of years, this selling was more than offset by huge buying by private foreign investors. The TIC data for March was released on Friday evening and the data showed little evidence overall of foreign investor flight from the US. Of course it was the price action in April that fuelled fears of foreign investor flight, but certainly in the month ahead of that there was limited signs of any loss of confidence in US assets – and this covered the period of Trump announcing tariffs on China twice – at the start of Feb and March – and the announcement of steel and aluminium in Feb and on autos in late March.

The TIC flow data revealed that foreign official entities bought USD 40.9bn worth of UST bonds in March but were modest sellers (USD 7.4bn) of Agency debt. Private foreign investors bought a large USD 82.4bn in March, which followed a huge USD 125.8bn worth of buying in Feb. Private foreign investors were also big buyers of corporate bonds (USD 56.5bn) and modest buyers of equities (USD 10.5bn). In fact the buying of corporate bonds was the largest since the record buying back in May 2007.The March buying was the fourth largest on record. One standout flow that could be seen as concerns over uncertainty and possible concerns from some investors over increased duration risk in sovereign securities was the buying by private foreign investors of t-bills. Purchases totalled USD 113.6bn in March, a one-month record total surpassing the previous record set during covid and before than the GFC.

The holdings data, also part of the TIC release, tells a slightly different story but we need to be cautious in our conclusions here. The holdings data revealed China’s total holdings of US Treasury securities (bonds, notes and bills) fell from USD 784bn to USD 765bn in March and that decline meant the UK surpassed China as the second largest holder of UST securities with its holdings increasing from USD 750bn to USD 779bn.

This of course is not a reflection of UK reserve holdings. Instead it reflects London’s crucial role in international finance and the role of intermediaries buying on behalf of entities domiciled elsewhere. Similarly, Belgium, where Euroclear is based, which operates as a central securities depository, has holdings of UST bonds totalling USD 402bn, and is the 7^th largest holder. Therefore we should not conclude that China has necessarily reduced its overall holdings of UST bonds, and certainly not to extent suggested by the China holdings total. The Moodys’ downgrade of the US sovereign rating serves as a reminder of the growing risk of foreign investors turning away to a greater degree from US Treasury securities, but the March TIC data certainly in total does not provide evidence of this taking place as of then.

FOREIGN PRIVATE INVESTOR VERSUS OFFICIAL ENTITY BUYING/SELLING OF US LONG-TERM TREASURY SECURITIES; USDMN

Source: Bloomberg, Macrobond & MUFG GMR

KEY RELEASES AND EVENTS

Source: Bloomberg & Investing.com