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Strategies & Market Trends : The Epic American Credit and Bond Bubble Laboratory -- Ignore unavailable to you. Want to Upgrade?

To: CalculatedRisk who wrote (26442)	2/14/2005 7:21:45 PM
From: CalculatedRisk	Respond to of 110194

Q&A with Setser (re:Roubini and Setser's new paper). Dr. Setser is a Research Associate at Oxford, served on the Council of Foreign Relations and worked for the US Treasury ('97 - '01). My Question for Brad Setser: If I'm reading correctly, you suggest that foreign CB purchases of US denominated assets has reduced American bond yields by as much as 200 bps. From your paper: "Considering the size of recent central bank purchases, the indirect impact of central bank intervention on private demand for Treasuries, the interaction between central bank reserve accumulation and Treasury debt management policy and the effects of Asian reserve accumulation on inflation and growth (general equilibrium effects), we would bet the overall impact would be closer to 200bps." I am curious at how you arrived at that number. Dr. Setser: We wanted to get your attention, so we had to put out a bigger number than Roach (just kidding). (MY COMMENT: Stephen Roach has put the impact between 100 and 150 bps) Nouriel (Dr. Roubini, Associate Professor at Stern School of Business) puts lots of emphasis on the general equilibrium impact of Asian central bank intervention -- i.e. it changes a host of other variables that impact the interest rate as well, notably inflation and growth, and so it not quite right to take all those variables as given and thus to search only for the autonomous impact of CB reserve purchases. I put more emphasis on three things, all which are hard to formalize: a) All the past studies basically work off data sets derived from a different period of time, when the scale of intervention was of a completely different magnitude. I.e. they try to estimate the impact of $450b of dollar reserve accumulation today by extrapolating from the impact of $50b in dollar reserve accumulation in the 90s. I doubt the impact is comparable. b) Central Banks probably bought the entire stock of new treasury issuance in 2004 (and certainly the entire stock not by the fed). That kind of accumulation, it seems to me, should have a bigger impact than 50bp. put differently, my gut says that there the US could go from placing less than zero in new treasuries in private portfolios at home and abroad to placing 350 b in treasuries with private investors are home and abroad for just 50 bp. The counter to this is that the price is set not by central bank buyers scooping up new stock, but by the price US investors are willing to hold their existing stock ... which is (perhaps) independent of whether central banks are buying the new stock. (the counter to the counter is one that peter garber and others have emphasized -- if you expect the bank of japan to jump into the fx market, and start parking the dollars it accumulates in the treasury market, and think that will have an impact of treasury market, you should think twice before you short long-term treasuries. see bill gross, among others, on this) c) Standard estimates of the impact of $100 b in corp profit repatriation (with $100 billion the stock of profits held abroad in foreign currency that may return to the US and be converted into dollars because of the tax amnesty) on the exchange rate estimate that 100 b in flows could move the broad dollar index by about 5%. Apply that metric to central bank flows, and the 400 b plus flows by central banks might be having a 20% impact on the exchange rate. Current treasury yields don't seem to fully compensate investors in the countries that have current account surpluses with the US (i.e. japan, emerging asia and the middle east as well as europe)for the risk of future dollar depreciation, and the gap between the return needed to cover the risk of future depreciation and the current return seems likely to be large, thought i have not done the math. But that sense adds to a general sense that the expected impact is more likely to be large than small -- foreign investors don't have to buy treasuries to support the US current account deficit, but they do have to buy US assets, and my general sense is that the price required to convince foreign investors to substantially increase their overall purchases of US assets and thereby fund say $500 b rather than $200 b of the 2004 US current account deficit is likely to be large. there are lots of very sophisticated folks on the street working on this, maybe some will chime.