Credit Ratings and International Capital Flows: Implications for the Dollar

Credit Ratings and International Capital Flows: Implications for the Dollar Dr. Catherine L. Mann

Barbara 54 and Richard M. Rosenberg Professor of Global Finance International Business School, Brandeis University Visiting Scholar, Federal Reserve Bank of Boston. CLMann @ Brandeis.edu

Debt Rating Agencies’ Role in the Global Debt Capital Markets: Past, Present, & Future Global Interdependence Center, Philadelphia February 2012

Outline •  Big picture on economic recovery •  Credit enhancements matter •  Prospects for international capital flows •  CDS commentary •  Implications for the dollar

Recession and Recovery: Output

Recession and Recovery: Employment

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Credit Enhancement Ma/ers: Foreign Official Purchases of Official US Assets

Foreign Official Investors increasingly bought Agencies: ‘same’ risk as UST and higher return

BEA, Intl Trans, table 5.

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Credit Enhancement Ma/ers: Cayman Islands holdings of ST Agencies

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Credit Enhancement Ma/ers: Europe (and CFC) bought AAA Asset Backed Bonds 63/73/.89#:34;5<#=3/91>4#?98#@A/BC.595# DE#/9>134##

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(Lack of )Credit Enhancement Ma/ers: Sloshing cross-­‐border inter-­‐bank funding dominates Millions$

Data: BEA ITA Tbl 1

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Credit Enhancement Ma/ers: Only gross flows of UST have recovered

Data: BEA ITA Tbl 8a

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Credit Enhancement Ma/ers: New high-­‐return, low risk asset– munis? '$!"

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CDS focus: Counter party risk, not payment risk

CDS focus: CDS, spreads, euro exchange rate

Implications for the Dollar: Appetite for US exposure? % of increase in global investor porQolio into US assets

Mann, How Long the Strong Dollar (2002); calculated 15 Using OECD financial data

Same methodology calculated Using IMF, CPIS data

Shrinking marginal allocation to US assets: Compared to late 1990s, global asset allocation rebalanced away from US assets

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Credit Ratings and the Dollar •  Credit ratings played a role in international asset allocation…. What now? •  Private portfolio allocation –  Plenty of headroom to reallocate toward US assets, but… maybe no appetite

•  Official portfolio allocation –  Own currency appreciation harmful to exports and growth…. but overweight dollars

•  Recipe for dollar volatility