This is the third entry in a series of posts on U.S. debt purchases by the foreign private sector during the past decade. An introduction and overview can be found here.
Every transaction, when observed at the most minute level is commonly thought to have two effects:
- a marginal price effect, which depends on the aggression of the involved parties and
- a change in ownership of the respective asset.
For most transactions (or bundles thereof), these effects are inconsequential at a macro level.
Sometimes however, while frequently still appearing inconsequential when viewed from a micro perspective, large unidirectional flows into similar assets by similar but distinct actors can have a lasting impact on markets. An impact which transcends the purely transactional nature of asset acquisitions and affects the market environment as a whole by altering
- who can issue at what yield levels and
- in what amounts.
At the same time, large inflows which fall into this category tend to create new linkages between hitherto unconnected balance sheets, which then have the power to – at times – shape the future trajectory of markets.
It is from such a perspective that the overseas inflows into U.S. debt this cycle will be analyzed in the following sections. Figure 1 is an attempt to map out – hopefully in a somewhat organized manner – the different layers at which foreign private inflows affect numerous financial markets.
The balance sheets of the principal actors involved – the issuer and the ultimate buyer – are placed on the very left and right of the diagram respectively. In between lie several layers affected by the purchases.
The analysis will commence by first focusing on the left half of Figure 1: discuss the effects of purchases on bond markets, the issuers and the broader economic environment. Afterwards, the concentration will shift to how institutions acquire the necessary funds in the first place and, closely related, how they deal with FX risk and the effects of their hedging structures on markets. This is figuratively speaking the right half of Figure 1. Continue reading “Effects, balance sheets and new linkages”