The dollar was crushed yesterday. The U.S. Dollar Index dropped more than 2%, reversing whatever gains were left from the now-evaporated summer rally.
The verdict, it would seem, is in. The forex market isn’t amused by the prospect of adding $700 billion-plus to the already bloated U.S. budget deficit. Jay Bryson, global economist at Wachovia Securities, summed it up neatly in a note to clients yesterday, explaining that “this weekend’s announcement that the U.S. government will buy up to $700 billion worth of bad debt from financial institutions is a short-term negative for the dollar. In order for investors to absorb the increased issuance of U.S. Treasury securities the returns on those securities will need to rise.”
Bryson adds that there are two ways for bond returns to rise from a foreign investor’s perspective. Yields can rise, which is to say that prices will drop. That seems plausible, given that $700 billion in new debt equates to roughly 15% of existing Treasury debt outstanding. The second way is a depreciation of the dollar.
Yesterday, we got both. The buck was slammed and the benchmark 10-year Treasury Note rose to 3.83%, the highest close in more than a month.
Why does this matter? Because foreigners will be ponying up a fair chunk of the $700 billion loan to fund the new bailout plan. As such, monitoring what foreigners think is more than a passing news story these days. One might wonder what might compel foreign central banks and offshore investors to further expand their already large holdings of Treasuries.