Commodity Drag to Spur Selloffs in Foreign-Held US Assets

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Commodity-based economies are poised to sell US debt and other assets in order to raise capital to cover their fiscal deficits, potentially threatening the stability of international trade and global development.

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Kristian Rouz – The era of late 20th century globalization might be coming to an end as regional fragmentation in the global economy increases amidst the massive depreciation in commodities and currency markets stirs greater imbalances in international trade. As the US dollar strengthens, foreign-owned US assets, most prominently, US Treasuries and other bonds, are prone to become subject to selloffs as cash strapped commodity-based economies will seek ways to boost their monetary resources, not least in order to finance development-aimed reforms.

The most recent shock to the international commodity markets stems from a further deceleration in mainland China’s industrial sector, combined with negative effects of Iran’s anticipated re-entry to the global supply of crude oil.

Profits of mainland China’s industrial enterprises decreased by 1.4% in November, according to data provided by the government in Beijing, exacerbating the negative outlook for the demand side of international oil trading. The mainland’s contraction in industrial profits has lasted for last six months, suggesting the ongoing economic reform in China implies its decreased reliance on the export-oriented industries. One of the biggest oil consumers, mainland China is expected to import less crude as the reforms progress.

Meanwhile, Iran has provided further evidence it would increase its presence in the oil market – on the supply side. According to International Monetary Fund (IMF) projections, in case the once-powerful oil cartel, OPEC, does not cut crude output in order to compensate for the increased Iranian exports, oil prices might drop further between 5% and 10% in the medium-term.

According to the international oil giant BP, Iran has the world’s fourth-biggest oil reserves after Venezuela, Saudi Arabia and Canada. Now that the US President Barack Obama has managed to fend off the Canada-related negative effects to the oil price by having vetoed the Keystone XL pipeline project (at a cost of tens of thousands of the US jobs), it might be difficult to prevent further drops in oil price stemming from Iran’s return to the markets.

Consequently, as the oil price declines, resource-based economies like Saudi Arabia, Brazil, Malaysia and Russia will need to compensate for their shrinking fiscal revenues by not only decreasing investment and overall governmental spending, but also by reducing their holdings in US assets. Foreign bondholders account for some 34% of the US national debt as of December 2014, according to the Federal Reserve figures. Among them, according to the US Department of the Treasury estimates, oil-exporting nations were holding some 1.6% of Treasury bonds as of spring 2015, subsequently increasing their cut during the rest of the year. Another 1.4% of US debt are held by Brazil, also a major oil exporter, among other things.

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Now, according to JPMorgan projections, while Saudi Arabia has an option to cover their fiscal deficit by issuing bonds, most other oil-exporters will have to sell their holdings in US debt.

“We are projecting a 30 percent decline in foreign interest in the U.S. bond markets, a significant decline,” Meg McClellan of JPMorgan Asset Management said.

The US Treasuries and other bonds and assets have been appreciating gradually during most of 2015 amidst the anticipation of the US Federal Reserve hiking rates. Now, after the actual hike in December, as the US economy is not strong enough, the rates will hardly go any higher.

According to JPMorgan projections, the US will issue another $300 bln worth of Treasuries throughout 2016. With international investors selling US assets, this might put rates under pressure price-wise. The yield is bound to rise, however, producing increased market volatility. Combined with the negative outlook for a large part of the world’s economy, US financial volatility will impose significant limitations on the scale and volumes of international trade, hitting already weak inflation in advanced nations, and undermining growth prospects elsewhere.

The good news for the global economy is, other US bond investors like Social Security, pension funds, insurers and the likes of Japan and the UK will either need or opt to buy into safe haven medium- and long-term Treasury notes. Other US assets will likely follow a similar pattern to that of the Treasuries. However, should foreign holdings in the US assets rebalance toward a greater involvement of the advanced nations from the currently wider global exposure, the looming imbalances in international trade will be hard or even impossible to avoid.

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