Dollar Scarce as Top-Quality Assets Shrink 42%
The dollar is proving scarce, even after the Federal Reserve flooded the financial system with an extra $2.3 trillion, as the amount of the highest-quality assets available worldwide shrinks.
From last year’s low on July 27, the greenback has risen against all 16 of its major peers. Intercontinental Exchange Inc.’s Dollar Index surged 12 percent, higher now than when the Fed began creating dollars to buy bonds under its extraordinary stimulus measures at the end of 2008.
International investors and financial institutions that are required to own only the highest quality assets to meet investment guidelines or new regulations are finding fewer options beyond dollar-denominated assets. The U.S. is one of only five major economies with credit-default swaps on their debt trading at less than 100 basis points, meaning they are viewed as almost risk free. A year ago, eight Group-of-10 nations fit that category, data compiled by Bloomberg show.
“The pool of high-rated assets has been shrinking, not just in the euro zone but elsewhere as well,” Ian Stannard, Morgan Stanley’s head of Europe currency strategy, said in a May 22 telephone interview. “With the core of Europe shrinking, and the available assets for reserve purposes shrinking, it makes the euro zone less attractive.”
Euro Depreciation
The dollar is gaining mainly at the expense of the euro, which has depreciated almost 5 percent in the past six months against a basket of nine major currencies tracked by Bloomberg as nations from Spain to Italy see their credit ratings downgraded amid the region’s sovereign crisis.
Spain, which has about $917.5 billion of debt, has been cut six levels by Moody’s Investors Service to A3 from Aaa in September 2010. Italy, with more than $2 trillion of debt, has been reduced four levels to A3 from Aa2 in October.
“We’re seeing many more periods of dollar buying during these uncertain times,” Ken Dickson, an investment director of currencies at Standard Life Investments in Edinburgh, which manages $257 billion, said May 24 in a telephone interview.
The U.S. currency appreciated 2.06 percent last week to $1.2517 per euro in New York after touching $1.2496, the strongest since July 2010. It gained 0.84 percent to 79.68 yen. The Dollar Index jumped 1.37 percent to 82.402, its fourth- straight weekly rally.
The dollar was little changed at $1.2550 per euro as of 9:56 a.m. London time today, and was also little changed against the yen at 79.51.
Bigger Share
The five economies with default swaps trading at less than 100 basis points have a combined $14 trillion in debt, with the U.S. accounting for 75 percent, according to CMA data compiled by Bloomberg. A year ago, when there were eight nations, the total was $24 trillion, with America making up 38 percent.
Bank of America Merrill Lynch’s AAA Rated Global Fixed Income Index contained 3,597 securities with the highest ratings as of April 30, down from a high of 5,331 in December 2007, the fewest since November 2005. Dollar assets make up 65 percent of the index, up from 56 percent in 2008.
Hungary’s central bank is among reserve managers diversifying foreign-exchange holdings as the credit quality of European assets declines. The central bank said it will include dollars, yen and British pounds in its reserves, currently invested exclusively in euro-denominated securities.
No ‘Master Plan’
“The number of euro-denominated assets that meet our quality standards has dropped radically,” Magyar Nemzeti Bank President Andras Simor told reporters on May 14 in Budapest. “More and more securities were dropped from our portfolio as the credit grade of more and more countries fell below the single A category and as more and more securities don’t meet our market quality requirements.”
China Investment Corp. President Gao Xiqing said May 10 the nation’s sovereign wealth fund stopped buying government debt in Europe as the region’s turmoil intensifies. With an estimated $440 billion in assets, CIC is the world’s fifth-largest country fund, according to the Sovereign Wealth Fund Institute.
“Ever since the debt crisis broke out, there has never been a master plan for a resolution,” Jin Liqun, chairman of CIC’s supervisory board, said at an event hosted by the Centre for Policy Studies in London on May 22.
Such comments are bolstering the dollar’s status as the world’s primary reserve currency after a decade-long decline.
Official Holdings
The greenback’s share of global foreign-exchange reserves climbed in the last three-months of 2011 to 62.1 percent, the highest since June 2010, while holdings of euros fell to the lowest since September 2006 at 25 percent, according to the latest quarterly data from the International Monetary Fund.
Foreign official holdings of U.S. government debt increased in each of the first three months of 2012, climbing by 3.24 percent to $3.73 trillion in the best start to a year since 2009, according to data from the Treasury Department.
Demand from outside the U.S. helps the administration of President Barack Obama finance a budget deficit forecast to exceed $1 trillion for a fourth year.
A relatively strong dollar may also damp criticism of the Fed if it decides to expand its balance sheet to boost the economy. The Dollar Index tumbled 14 percent during the Fed’s two rounds of asset purchases, known as quantitative easing, or QE, between December 2008 and June 2011.
‘Way Oversold’
While the dollar is “somewhere safe to hide,” the euro is poised to rebound before Greek elections next month before resuming its decline against the U.S. currency, said John Taylor, founder of New York-based currency-hedge fund FX Concepts LLC, which oversees $3.9 billion.
“We are way oversold in the euro,” Taylor said on May 24 in an interview on Bloomberg Television’s “Inside Track” with Erik Schatzker and Sara Eisen.
The dollar’s appeal is also getting a boost as nations generally perceived as havens become less welcoming.
The Swiss National Bank introduced a 1.20 franc-per-euro limit in September after its currency rose to a record, hurting exporters and increasing the risk of deflation.
Japan spent 16.4 trillion yen ($206.6 billion) in intervention in 2010 and 2011, according to the Finance Ministry. The franc has lost 1.9 percent against the dollar this year and the yen has depreciated 3.1 percent.
“The other countries that often have some kind of a safe- haven attraction to them are slowly but surely saying that we’re not so sure we want our currencies to be stronger,” Standard Life’s Dickson said.
Bank Demand
Demand for dollars is also showing up in financial institutions needing to meet Basel III regulations set by the Bank for International Settlements. The new rules on capital reserves will “increase the price of safety” embedded in assets deemed a reliable store of value, the IMF wrote in an April 18 report.
The cost for banks to convert euro interest payments into dollars through the swaps market for three years has increased to 67.8 basis points below the euro interbank offered rate, or Euribor, from 34.8 basis points below in March 29, according to data compiled by Bloomberg. Negative spreads show a premium for dollar funding.
Dollar assets are also looking attractive on a relative basis, with yields on Treasuries due in 10 years averaging 0.37 percentage point more than German bunds of similar maturity. As recently as November, Treasuries yielded about 0.33 percentage point less than bunds.
“With the chronic problems and challenges in Europe, it’s hard to see how that’s going to overtake the dollar anytime in our lifetime, if the euro even still exists in our lifetime,” Tim Adams, a managing director at the Lindsey Group, a Fairfax, Virginia-based investment consultant and former Treasury undersecretary, said May 1 at the Bloomberg Washington Summit hosted by Bloomberg Link.
To contact the reporter on this story: John Detrixhe in New York at jdetrixhe1@bloomberg.net
To contact the editors responsible for this story: Dave Liedtka at dliedtka@bloomberg.net
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