US assets continue to draw international flows, predominantly from Japan, but the level of support may not be sustainable to keep the dollar strong, according to new research by contrarian hedge fund Horseman Capital.
In a note this week, Russell Clark, who leads the long-running London-based global equities hedge fund firm, observed how US Net International Investment Position (NIIP) as a percentage of GDP is now close to 50 per cent of GDP deficit, while private sector deficits in China and Europe are close to zero – implying “almost all flows” from Japan are heading to the US.
Clark – whose USD800 million Horseman fund suffered a torrid 2019 after a series of bearish bets went awry – drew comparisons between current US volumes and historical flows into China and Europe.
He said the 2008 global financial crisis saw China draw in heavy international asset inflows, driving down its private sector NIIP to USD2.5 trillion, or 20 per cent of GDP, before the renminbi had to devalue.
Similarly, pre-2008 Europe enjoyed significant credit flows, driven by trade convergence between peripheral and core Europe. Again, the euro reached a deficit of 20 per cent – or USD2.5 trillion – before the eurozone crisis and subsequent devaluation.
US quarterly data suggests US private NIIP has just passed USD4 trillion, Clark noted.
“Today, the US is sucking in huge amounts of capital. Its private sector NIIP is running a 20 per cent deficit while the public sector is running a 30 per cent deficit. The top seen in the 2000-2001 period of US NIIP deficit was followed by dollar weakness. The US dollar, as proxied by the JP Morgan Nominal Broad Effective Exchange Rate, also looks to be topping out.
“With the US running USD1 trillion fiscal deficits, even the Japanese may not have enough money to keep the US dollar strong,” he said.
He added: “Generally the Japanese used to buy foreign bonds when the yen was strong and sell them when the yen was weak. Since 2013, Japanese purchasing of foreign bonds has been strong even without the yen strengthening. This is exactly what Abenomics and Bank of Japan activism was intended to do. That is, Japanese fund flows would be less countercyclical and more pro-cyclical. In other words, fund flow was not meant to take advantage of yen strength, but to stop yen from strengthening in the first place.
“This has caused the traditional relationship between Japanese and US 30-year bond spreads against the yen exchange rate to breakdown.”
Horseman’s global equities fund collapsed 35 per cent over the course of last year, as a global stock market surge sent his long-standing negative positions into a tailspin.
