The retreat of foreign investors from US assets after April’s ‘Liberation Day’ tariff bazooka may be over already: US Treasury International Capital (TIC) data showed significant net foreign purchases in May. Elsewhere, Chinese stocks have recovered more strongly than US shares since June, suggesting investors see Beijing’s latest stimulus measures as likely to boost China’s recovery.
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Foreign investors return to US assets
Investor concerns over a raft of US issues intensified from early April. Could the country still finance its bulging current account deficit at 6% of GDP? Would President Trump’s unfunded tax cuts, high import tariffs, and squeeze on immigration lead to larger fiscal deficits, a higher debt burden, and a slowing economy? As ‘US exceptionalism’ faded, investors simultaneously sold US stocks, bonds and the dollar.
A reassessment followed quickly, however, cutting short the sell-off. Treasury data released on 17 July shows net foreign buying of US assets in May (see Exhibit 1). The dollar, however, has remained weak. What explains the dichotomy between this stronger demand for US assets and a sagging dollar?
TINA for US assets
Economic fundamentals suggest ‘there is no alternative’ (TINA) to US assets in the medium term. The clue is in the country’s balance of payments (BoP): the deficit in its current account (which mirrors the shortfall in US savings) must be offset by a surplus in its capital account. Those funds should be coming from countries with current account surpluses (i.e., excess savings).
Who are these countries?
The big ‘surplus four’ are China, the eurozone, Japan and Gulf Cooperation Council members1 whose sizeable domestic savings exceed demand for investments at home, meaning they are looking for external placement opportunities.
At the prevailing exchange rates, these four economies are running an aggregate current account surplus of about $1.3 trillion — almost equalling the US’s current account deficit. That makes the US’s deep and liquid financial markets a natural home to absorb such a large savings glut (see Exhibit 2).
Historically, these large savings surpluses have been recycled for the most part into US assets. Given the lack of obvious alternatives, this will likely continue. If foreign countries (and by implication, investors) wanted to stop funding the US deficit, they would have to address their current account surpluses, which could be done by boosting domestic spending and investment.
Since we would not expect such a global structural rebalancing to happen quickly, US assets look set to continue to be in demand.
Hedging has pressured the dollar
So, if there is persistent demand for US assets, why is the dollar weak? The Bank for International Settlements (BIS) argues in a June report that an increase in hedging activity by non-US investors has been the main culprit, especially since April.
Foreign investors did not hedge dollar risk for most of the post-pandemic period because high US interest rates made hedging not worthwhile when the dollar was strong. That has changed, however, since the start of this year, when the dollar started weakening as investors responded to higher US policy uncertainty.
With the dollar slumping, foreign investors in US assets boosted their hedging ratios (which were low according to some estimates) to mitigate against the risk of foreign exchange losses. A vicious dollar-hedging cycle could develop in the coming months as expected weakness in the US economy and more central bank interest rate cuts continue to weaken the dollar and prompt yet more hedging.
Chinese equities – Recovering
Meanwhile, China’s stock market has recovered from the initial US import tariff shock with greater panache than the US market (see Exhibit 3).
This is partly the result of Beijing delivering on pledges for policy easing: 70% of the planned fiscal stimulus of 1.5%-2.0% of GDP has already been implemented in the first half of the year. That input helped sustain economic growth at 5.2% year-on-year in the second quarter after 5.4% in the first – even in the face of intensifying trade and geopolitical headwinds.
The question for investors is now how much more stimulus can be expected from China’s authorities. Given the sticky deflation — the GDP deflator fell by 1.3% annualised in the second quarter — and China’s fragile economic recovery, it appears that Beijing fully intends to deliver on the remaining part of its planned fiscal stimulus in the form of more consumer subsidies and new measures to stabilise the property market.
The People’s Bank of China (PBoC) is expected to provide support by cutting interest rates by 20-30bp in the rest of this year. Faced with more challenges in the coming months, Beijing says it is also prepared to increase fiscal stimulus by a further 0.5% of GDP. This would be funded by special government bonds.
Continued stimulus should allow Greater China stocks to recover further. The key policy development to watch is whether Beijing shifts towards more social transfers and consumption support rather than boosting capital spending. Recent statements suggest it may make that policy shift.
[1] The Gulf Cooperation Council (GCC) is composed of six member states located in the Persian Gulf region of the Middle East: Bahrain, Kuwait, Oman, Qatar, Saudi Arabia, and the United Arab Emirates.
