An interesting report out today from NatWest Markets looks at the effect US investors have on the value of the US dollar and the relative swings in its value. According to Federal Reserve data American fund managers hold $85trn of liquid assets dwarfing global central banks reserves at $12trn and sovereign wealth funds at $5trn.
Of the $85trn, $12trn is in foreign assets, which is about 14%, and it has been growing steadily since the 1970s when foreign assets were just 2% of total assets. To show the impact this amount of flows can have on market pricing, in 2017 American investors added $715bln in foreign assets which added to the US current account deficit of $449bln that year and of course weakened the US dollar. Indeed the DXY or trade-weighted dollar index fell from 104 in at the start of 2017 to just 88 in early 2018. In 2008 US investors cut foreign assets by $564bln almost funding the current account deficit that year of $711bln and the US dollar rallied.
The report argues that Americans’ dollar diversification has the potential size and scope to weaken the greenback. It also underscores how the currency tends to underperform when investors are risk-seeking and outperform when investors become risk-averse.
Thus even if all sovereign wealth funds suddenly lowered the share of their total assets denominated in dollars by 20% in their portfolios, the adverse impact on the greenback would be matched if American fund managers diversified just over 1% of their overall assets out of dollars at the same time.
Over the last two decades, the US dollar has fallen from 72% of Central Bank total reserves to around 62% today, however, it’s the flows from American investors which greatly exceeds that amount, especially when investors look to repatriate in times of stress.