The falling dollar hasn't prompted foreign investors to pull their money out of dollar-denominated assets, much to the surprise of some market watchers. But the future may not be so rosy.
For the time being, foreign investors are pouring big bucks into the U.S. Foreigners purchased $102 billion of agency and mortgage-backed debt in the first three months of the year and $247 billion of corporate bonds, according to data from Merrill Lynch. That's up from $43 billion and $164 billion, respectively, in the fourth quarter. In addition, private investors abroad bought some $59 billion in U.S. Treasuries in the first quarter, compared with $51 billion in the fourth quarter.
"As weak as the U.S. economy is, Europe is worse and Japan is worse yet," said Merrill's senior economist, Stan Shipley. "The U.S. still has the best long-term prospects."
At the end of March, foreigners owned about one-third of all Treasuries, 12% of agency debt and 21% of the corporate market, Merrill noted. Although nonresidents did sell U.S. equities to the tune of $8 billion in the first quarter, foreign ownership of stocks is still close to an all-time high of 11%. So it's not surprising that some analysts have expressed concern about the decline in the dollar this year. After all, a sagging dollar reduces the value of stocks and bonds to foreigners. If overseas investors expect the greenback to decline further, they might consider cashing out.
And a mass exodus of foreigners could be devastating because these investors are principally responsible for financing the current account deficit. The account deficit, which is the trade balance plus incoming and outgoing interest payments on foreign investments, grew to $142 billion in the first quarter, according to consensus estimates, up from $136.9 billion in the fourth quarter. The latest data are slated for release Thursday.
Some economists worry that another cut in interest rates by the
next week will undermine the dollar further and prompt investments to slow. Merrill's chief economist, David Rosenberg, said that while "foreign investor willingness to buy U.S. assets and securities so far has helped prevent the U.S. dollar's decline from becoming destabilizing for domestic financial markets, there is no guarantee that this will continue indefinitely."
Paul Kasriel, chief economist at Northern Trust, agrees, saying that one quarter "does not a trend make." He worries that investors could pull out money from the U.S. or at least invest less money here in the future.
"I think it's a distinct possibility because the rest of the world may begin to wonder how we're going to pay the interest in dividends on the approximately $1.5 billion a day that it advances us," Kasriel said. "We're basically using those advancements now to throw a party for America. We're buying bigger cars, bigger houses and cruise missiles, and this is not the stuff of faster productivity growth."
Nonetheless, the dire prognostications of foreigners departing en masse haven't come true so far this year.
One reason for this, says David Gitlitz, chief economist at Trend Macrolytics, is that a drop in the dollar has actually attracted more foreigners by making U.S. assets less expensive. "If the dollar continues to decline, you can expect to see a currency loss on your initial investment, but the dollar's decline has also made new investments cheaper to buy," he said.
Kasriel of Northern Trust said the Bank of Japan has been a big buyer of U.S. Treasuries because it has tried to stem the appreciation in its own currency.
"They send us goods and we send them dollars," he said. "Then those people exchange the dollars for their own local currency and in order to prevent their currency from appreciating, central banks just recycle those dollars and buy U.S. Treasuries."
Smith Barney analyst Tobias Levkovich also notes that a large portion of Treasury investors have come from China, where the local currency is pegged to the dollar. This means a significant decline in the dollar has done little to devalue their investments here.
A Chinese official, speaking anonymously, said the country has no immediate plans to end the yuan's fixed value after Treasury Secretary John Snow said the county was thinking of shifting to a flexible exchange rate, according to
. Of course, if this policy changes it could have significant ramifications, with China dumping Treasuries or buying less aggressively.
Because data on foreign inflows are delayed, it's not easy to determine how things progressed in the second quarter, but anecdotal evidence suggests that overseas investors have continued to pour money into U.S. assets.