US current account will be always fully funded – Westpac

The US current account will be always fully funded but the underlying flow composition can still provide insights about the USD, according to Richard Franulovich, Research Analyst at Westpac.

Key Quotes

“One such indicator is the “basic balance”, the sum of the current account, net direct investment and net portfolio flows. After improving sharply in recent years, the basic balance has deteriorated lately, corroborating the weak USD. The deterioration in the basic balance has been driven entirely by capital flows:

• Net portfolio debt, which accounts for the bulk of current account financing has eased, despite higher yields. 2017 saw $275bn in net portfolio debt inflow, the lowest annual pace since early 2013. Higher US demand for foreign debt and slower foreign demand for US debt have contributed in equal parts.
• Net portfolio equity flow has deteriorated too. At their height, net portfolio equity outflows exceeded 2% of GDP in 2015 & 2016H1 but improved sharply in the year to mid-2017, due to surging foreign demand, arguably attracted by Trump’s pro-growth reflation policies. However, since then, even though foreign demand has continued to firm, the net portfolio equity flow picture has deteriorated due a recovery in US appetite for overseas portfolio equity.
• Net direct investment into the US has crested too, from a peak of +1.3% of GDP in the year to 2016Q3 they have since almost halved to 0.8% of GDP. The Trump/Republican tax plan should have boosted the expected return on US investments via lower corporate tax rates and the introduction of immediate 100% capital equipment expensing. While the plan only passed in Dec 2017 hopes have been soaring for a solid year and the tentative evidence is underwhelming: US direct investment overseas (excluding reinvestment) is unchanged in 2017 at $30bn, the same as 2016, while foreign direct investment into the US has if anything slowed, to $185bn in 2017 from $254bn in 2016.”

“The net result is that after improving for several years the US basic balance has weakened in recent quarters.”

“Perhaps not coincidently, the USD was on a clear uptrend when the basic balance was firming in recent years but has softened more recently at the basic balance has deteriorated.”

“US government dissaving is of course set to increase sharply going forward.”

“Against that backdrop some mix of both higher yields and a weaker USD may a necessary part of the adjustment to these shifting savings-investment trends, especially with a global growth upswing enhancing investment opportunities outside the US.”