THE FOLLY OF PARTIAL EQUILIBRIUM THINKING: FALLING CENTRAL BANK FX RESERVE GROWTH IS NOT = RISING TREASURY YIELDS

Measuring the growth of global foreign exchange reserves was a popular macro-analyst pass-time during the pre-crisis low vol hey-days. This exersize was conducted to gauge the central demand for U.S. Treasuries. The simple conclusion from this analysis was that slowing official asset accumulation would result in declining demand and rising Treasury yields. This argument misses one crucial point.

The rapid ascension of official reserve assets was a result of the US current account deficit. The only scenario in which this deficit would have corrected was some combination of a rising US savings rate and falling investment. Thus, in the event of a sharp contraction of the trade gap, net issuance of various kinds of securities would have fallen as well. Clearly, in such a scenario, there would have been no pressure on yields to rise.

A cursory look at the US flow of funds data tells us that net issuance of various fixed income products is down sharply and the rising household savings are finding their way into the treasury market. Consequently, there seems to be no pressure on yields to rise even when foreign exchange reserve growth has slowed down (even in the face of mammoth issuance).