In a sign that the US's ability to finance its trade and current account deficits is in danger, a report out on Thursday suggested US investors are starting to find confidence and value in foreign securities.
Just as worrisome, foreigners, too, may be starting to lose their appetite for US securities.
According to a report from the Treasury Department, net foreign acquisition of long-maturity US securities, or net capital inflow, tumbled to US$15.6 billion in December, down 82 percent from US$84.9 billion in November. Meanwhile, the US trade deficit came in at US$61.2 billion.
This "warns that (a) foreigners are finding US asset markets a little rich and (b) US investors may finally be more attracted to returns in offshore markets," said Chris Turner, currency strategist at ING Capital Markets in London.
Net capital inflow represents money flowing into the US, while the US trade deficit represents money flowing out of the country. The best scenario for the economy is when the two balance each other.
But Turner and other analysts are quick to note that the data should be read as merely a rough guide. The report, they point out, is prone to volatility and upside revisions in future months. And, besides all that, one month's data do not a trend make.
They also point out that the figures are a so-called lagging indicator from two months ago. Given that the dollar's value against the euro and other rivals has been relatively stable since December, investors must still be buying dollar-based assets, though perhaps in investments other than long-term securities.
The dollar immediately fell against the euro and the yen after the report's release, but the dip was rather modest, and the dollar's losses were mostly reversed later in the session. By mid-afternoon, the euro was trading at US$1.3138, off its intraday high of US$1.3173 seen after the Treasury data, from US$1.3125 late Wednesday. The dollar was at ?119.50 from ?119.45.
But Thursday's data brings new urgency to how the US finances its deficits, and testimony from Federal Reserve Chairman Ben Bernanke on Wednesday on Capitol Hill shows that politicians were already worried.
Bernanke was specifically asked by a senator whether he is concerned that US investors may be buying foreign-based assets instead of investing in homegrown assets.
Bernanke said no, that he believes it's healthy for investors here to diversify their portfolios to include foreign assets, because it could encourage foreigners to do the same, investing more in the US.
The problem, though, is that for the US to finance its twin deficits, it needs foreigners to invest here more than the US invests abroad.
A specific concern, said Mitul Kotecha, head of global currency research at Calyon Corporate and Investment Bank, is that foreigners sold a net US$11.6 billion in US stocks in December, a reversal from net purchases of US$7 billion in November.
"The huge appetite for foreign assets and weakness in inflows into US stocks is a worrying development that could alter markets' current benign attitude to the US current account deficit and its financing," Kotecha said.
Net foreign stocks and bonds purchased by US residents was a record US$47.4 billion in December.
This, said Ashraf Laidi, chief foreign exchange analyst at CMC Capital Markets, signals "that the reason [for] falling net flows into the US is not only a result of foreigners' actions with US assets but also US residents' surging interest in non-US assets."
Turner said a drop in net foreign acquisition of long-maturity US securities suggests that foreign investors instead are putting their dollar-based investments into short-term "hot-money flows," such as three-month or one-year bank deposits.
As far as preferred investments goes, these are the least desirable for the US, Turner said, because investors can get out of these "at the drop of a hat."
"The best investments are money that sticks, like foreign direct investment: you build a plant, it stays there," he said.
"Next would be a portfolio in Treasurys and corporate bonds and equities," he added.
The risk to the dollar, then, is that investors shift their short-term deposits into British pounds or other currencies if official interest rates begin falling in the US, making investments more profitable elsewhere.
Currently, one-year dollar deposits are paying about 5 percent, based on expectations that the Fed may cut its 5.25 percent interest rate to 5 percent in the fourth quarter. But investors can get a better return in the pound right now. Although the Bank of England's key lending rate is also 5.25 percent, expectations are that the central bank may hike rates up to 5.75 percent over the next several months.
What may need to happen for the US to again start attracting foreign interest is to start offering higher returns, Turner said. That means higher interest rates.
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