ANALYSIS - Dollar at risk as global investors quietly exit US
Monday December 16, 1:48 am ET
By Yoshiko Mori
TOKYO, Dec 16 (Reuters) - The Japanese government has long been the world's largest and most loyal holder of U.S. Treasuries, but Japanese private-sector investors are no longer committed buyers of U.S. bonds, regarding the returns as too low for what they see as the risks inherent in U.S. markets.
This illustrates a potential threat to both the dollar and the smooth financing of U.S. debt, as not only Japanese but also Europeans are quietly pulling out of U.S. markets.
On Friday, the euro rose to $1.0260, its highest rate against the dollar in nearly three years, as increasing concern about geopolitical risk associated with Iraq and North Korea undermined the greenback.
But analysts say the dollar's appeal to global investors was dimming well before the geopolitical risk set in.
"The United States has successfully lured global capital into its financial markets for the past seven years on the back of the strong dollar policy and the stock market boom," said Kazuo Mizuno, chief economist at Mitsubishi Securities.
"But it's getting harder and harder for them to ensure external financing, as potential returns on investment (in the U.S.) become too marginal in the eyes of foreign investors."
Given the weak state of global equity markets, a country seeking foreign capital needs to keep reducing interest rates to maintain stable foreign capital inflows by increasing chances of capital gains on bonds, he said.
"Unfortunately, there is not much ammunition left for them (the U.S.)," he said. The trend-setting U.S. federal funds rate is now at a four-decade low of 1.25 percent.
COMPARATIVE ADVANTAGE
European rates have a comparative advantage over the United States even after the European Central Bank (ECB) lowered its benchmark rate recently by half a percentage point to 2.75 percent. The ECB has more scope than the U.S. Federal Reserve to cut its rates further.
Apparently sensing the danger of more capital flowing out of U.S. markets, Fred Bergsten, head of the Institute for International Economics, a Washington think-tank, told CNN earlier this month that there is now a huge differential between European rates over U.S. rates and that the ECB has got to move interest rates down.
The benchmark 10-year German bond yield was at 4.321 percent on Friday, compared to the 10-year U.S. Treasury note yield of 4.050 percent on Monday.
Japanese investors, who in the past have been active buyers of U.S. bonds, may now find they have more of them than they would wish, with interest rates too low and buffers against risk too small.
Chances that the administration of President George W. Bush could start to sound a more exporter- friendly line emerged after Bush's sudden move to appoint a new economic team last week.
"It's basically a no-way-out situation. If they advertise a weak dollar policy they will alienate foreign investors more. And if they keep the 'strong dollar' propaganda up, they will choke U.S. exporters," said a senior Japanese bank trader.
The only viable foreign exchange policy for the United States would seem to be to say nothing, he said.
The U.S. Treasury Department said it had "no comment" and "nothing new" to say on dollar policy on Monday of last week, the day when Bush announced he was replacing his Treasury secretary.
"I observe that the United States is entering into a risky game of tacitly accepting a gradual dollar fall initiated by the market," said Masaaki Kanno, managing director of economic research at J.P. Morgan Securities Asia.
Though this policy may not involve any imminent danger, it could lead to a sharp and sizable fall in the dollar when the U.S. current account deficit and budget deficit grow significantly larger.
DOLLAR OVERHANG
But investors may be sensing the danger already.
According to data from Japan's Ministry of Finance, Japanese investors bought a net 1.09 trillion yen ($9.04 billion) worth of foreign bonds and stocks in October.
Of the total, 717.7 billion yen or 66 percent was spent on investment in the European Union, and only 107.8 billion yen or 9.8 percent was spent on U.S. bonds and stocks.
"Japanese institutions were aggressive buyers U.S. bonds from the middle of this year, but by October they must have found they had an excess of them, and thus funds shifted elsewhere," said a Finance Ministry official.
The high ratio of European securities purchases by Japanese in October, at 66 percent, compared to an average of only 28 percent in the five months to September. Going back further, Japanese dumped 3.16 trillion yen worth of European securities in January-April.
Among the large Japanese investors in foreign assets, the nation's third-largest insurer, Sumitomo Life Insurance Co Ltd, boosted its euro-denominated assets to 188.59 billion yen by the end of September from 3.52 billion yen at the end of March 2001.
"We have increased our euro bond holdings as we see more opportunities for capital gains there," said Mitsutoshi Mise, general manager of the finance and investment planning department at Sumitomo Life.
Meanwhile, Japan's publicly offered investment trusts increased their holdings of bonds and stocks from euro zone issuers to 1.45 trillion yen by the end of October, against 875.7 billion yen a year earlier.
EUROPEANS ALSO SHIFT AWAY FROM U.S. MARKETS
As Japanese investors increasingly favoured European assets, European investors withdrew some money from American markets.
U.S. Treasury data shows net purchases of U.S. long-term securities, including Treasuries, agency bonds, corporate bonds and stocks, by Europeans excluding British investors nosedived to $18.49 billion in January-September compared with $78.92 billion for the whole of 2001.
ECB data shows that the euro zone had foreign capital inflows of 25.1 billion euros in January- September, reversing an outflow of 85.2 billion euros in the same period last year.
"The euro is slowly but steadily eroding the key currency status of the dollar as more investors favour the single currency," Mizuno said.
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