Why markets tanked and the dollar soared in Oct

Why markets tanked and the dollar soared in Oct

Data on US cross-border financial flows for October is now out and show that foreigners sold a net $34.8 billion (Rs1.6 trillion today) worth of US long-term securities that month.

This is the largest sale figure since August 2007, when the credit crisis first reared its head. On the other hand, foreigners stepped up their buying of US short-term treasury bills massively, which not only pushed the yields on these instruments to very low levels but also boosted the US dollar.

Also Read Massive selling in Oct (Graphic)

This is an indication of the extent of risk aversion, as nobody wants to hold even long-dated government bonds but prefers the safety of short-term US treasurys.

What is perhaps more interesting, from our point of view, is the amount of foreign securities sold by US residents. This is listed in the treasury data as “net foreign securities purchased from US residents" and it amounted to a net $36.3 billion last October. Out of this amount, $14.5 billion was on account of the sale of bonds and $21.8 billion was from the sale of equities.

Recall that October was the month when equity markets plunged to new lows worldwide as risk aversion rose sharply after Lehman Brothers was allowed to fail. We took a look at the data right from when it started in May 1978 and found no month during which such a large amount of foreign equities had been sold by US residents. Sales of foreign bonds were lower than in September, which saw bond sales worth $37.8 billion, another record.

Total sales of foreign bonds and equities by US residents totalled $126.1 billion in the four months to October. It’s no coincidence the US dollar index began its long climb upwards last July.

But sales of foreign equities by US residents have been a mere $ 8.4 billion in the 12 months to October 2008, while bond sales have been $69.6 billion. That’s not much. Moreover, even in September 2008 US residents had bought a net $2.4 billion worth of foreign equities.

The difference is that during the 12 months to October 2007, US residents purchased $146.2 billion worth of equities and $169.3 billion worth of bonds from foreigners. So the amount of foreign equity purchases by US residents has actually fallen by $154.6 billion in 12 months ($146.2+$8.4 billion).

This is the amount of liquidity being supplied by US residents that has been withdrawn from the non-US markets in the last 12 months.

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