Steve Blitz Morning Notes

Today's release of Treasury's International Capital data for June points up a surge in net private purchases of U.S. domestic securities (Treasury, Agency, corporate and equity) of $105.2 billion compared with $31.3 billion in May. The U.S. debt markets need net foreign private capital inflows to sustain pricing at non-distressed levels. The chart below tracks these flows against the two-year U.S. swap spread -- an excellent indicator of market sentiment regarding bank credit and corporate credit overall.

Sustained foreign inflows in this decade kept swap spreads from rising even though the Fed was raising interest rates and the yield curve was flattening. Historically, swap and credit spreads widened when the Fed tightened and narrowed when they eased. Looking forward, the return of foreign appetite for U.S. domestic securities alleviates the near term pain but does nothing to solve or even address the longer run problem of U.S. capital market dependency on foreign inflows. If the Fed and Treasury fail to address this issue directly, it is easy to see how a reversal of foreign market sentiment creates immediate dislocations in market pricing and, by extension, liquidity.