Given recent geopolitical jitters, Wednesday's tally of international capital flows into U.S. securities is going to take on new meaning.

The Treasury is expected to report that international capital inflows rose to $65 billion in January, an improvement from December's $56 billion, according to Lehman Brothers.

That would be cause for celebration, except that, despite the gain, the money still isn't enough to finance the U.S.'s debt with the rest of the world. The current account deficit, which compounds trade and investment flows, was $68.5 billion in January.

If capital inflows fall below that number, as Lehman expects, it would be the second month in a row that they fail to match the current account deficit.

The existence of a deficit means that the U.S. is importing more goods and money than it produces; it must be financed by foreign purchases of U.S. securities. When it isn't, the dollar must fall and/or interest rates must rise to make it attractive again for global investors to invest in U.S. assets.

To a certain extent, the January number is already discounted in the market. The dollar took a hit Tuesday on word that the current account deficit had swelled to $224.9 billion in the fourth quarter of last year. For all of 2005, the deficit reached a record $804.9 billion, or 6.4% of gross domestic production.

Stocks, however, rallied Tuesday as bond prices jumped, reversing recent weakness and easing the competitive pressure of rising bond yields on equities. The benchmark 10-year Treasury bond rose 19/32, while its yield, which moves inversely, dropped to 4.69%.

The bond rally came on the heels of weaker-than-expected retail sales in February and a report by hedge fund research firm Medley Global Advisors suggesting the Federal Reserve will stop raising interest rates after one or two more rate hikes.

The Dow Jones Industrial Average rose 75 points, or 0.7%, to 11,151. The S&P 500 gained 1.04% to 1297 and the Nasdaq Composite rose 1.3% to 2295.

Interest rate-sensitive stocks, such as homebuilders KB Home ( KBH) and Toll Brothers ( TOLL), also rose sharply.

Financial issues were boosted by blowout earnings from Goldman Sachs ( GS).

Lehman economist Drew Abate believes that foreign inflows are still reaching U.S. assets at "a very healthy rate." However, the shortfall between inflows and the deficit "will likely prompt further debate about the unsustainability of the U.S. current account and could weigh on the dollar," he wrote in a note.

Besides simple economic logic, concerns about the deficit have also been heightened by growing geopolitical tensions that are testing the willingness of foreign investors to finance the deficit.

The United Arab Emirates (UAE) said on Monday that it was considering shifting 10% of its $23 billion foreign currency reserves into euros from dollars.

Not coincidentally, the announcement followed congressional opposition to Dubai Ports World's acquisition of six U.S. ports. The impasse forced the UAE company to give up the U.S. ports, which were part of its purchase of a British operator.

"This is the first time that an Arab Gulf state expresses its intention to reduce its dollar holdings," notes Ashraf Laidi, currency strategist at MG Financial. This, he writes, "ranks high in the worst-case scenario for the U.S. currency, depending on the extent of the shift of reserves and on whether the trend will be pursued by other Arab Gulf nation states."

Following the UAE's announcement, Saudi Arabia also signaled it would bring back some of its petrodollars invested abroad to finance expansion at home.

The Organization of Petroleum Exporting Countries, of which Saudi Arabia is the largest member, owns roughly 5.4% of all U.S. bonds issued by governments, central banks and international agencies, according to Bloomberg.

According to the Bank of International Settlement, OPEC countries have purchased roughly $277 billion of U.S. securities between 1999 and 2005, including $15.7 billion of equities. These numbers, the BIS notes, probably underestimate the real inflows, as OPEC investors can purchase U.S. assets via hedge funds or private equity funds.

The problem, notes Laidi, is that cordial relations between the U.S. and Arab Gulf states have provided "one of the most crucial defense mechanisms" shielding the dollar from the risks of diversification of foreign holdings.

The U.S. Treasury has already been pressuring China, the largest holder of U.S. Treasuries behind Japan, to let its currency appreciate, a move that would lead China to reduce its reserves of dollars and of Treasuries. On Tuesday, Treasury undersecretary Tim Adams extended the pressure to Japan, saying it should not "artificially" prevent the yen from strengthening.

Last week, the Bank of Japan took a first step toward unraveling an ultra-easy monetary policy that has kept Japanese rates near zero for five years, a move that should logically boost the yen.

Likewise, the euro has been gaining ground against the dollar in recent weeks after the European Central Bank lifted its key rate to 2.5% and signaled more to come.

The U.S. fed funds rate, at 4.5%, still provides an advantageous yield to entice global investors into U.S. bonds, which supports the dollar. But current expectations that the Fed will soon stop raising rates, which is the reason why bonds and stocks rallied Tuesday, wouldn't bode well for any U.S. assets.
In keeping with TSC's editorial policy, Godt doesn't own or short individual stocks. He also doesn't invest in hedge funds or other private investment partnerships. He appreciates your feedback; click here to send him an email.