Dollar Repatriation First Since Lehman Evokes Post-LTCM Gain
Until about four months ago, JKMilne Asset Management invested at least half the money in its global fund outside the U.S. No more. With Europe’s debt crisis intensifying, the Fort Myers, Florida-based firm with $1.8 billion under management has all its money in dollars.
“It’s been a winning strategy,” John Milne, chief executive officer, said July 26 in a telephone interview. “Given the magnitude of the problem, there was the realization that there was a contagion possibility.”
Milne has plenty of company. U.S. investors repatriated $48.9 billion from December to May, the first time they brought assets home during a six-month stretch since the period following the failure of Lehman Brothers Holdings Inc. in 2008, according to Treasury Department data compiled by Bloomberg. The flows are among the biggest since 1999, after the collapse of hedge fund Long-Term Capital Management LP boosted the dollar as funds retreated from all but the world’s safest assets.
IntercontinentalExchange Inc.’s Dollar Index has risen 3.3 percent this year as investors moved cash into funds that focus on U.S. bonds. Inflows more than doubled to $157 billion in the first six months from $65 billion during the same period a year earlier, while international bond investments were unchanged, according to TrimTabs Investment Research.
The flows help explain why global financial institutions from UBS AG to Bank of Tokyo-Mitsubishi UFJ Ltd. expect the dollar to strengthen by year-end as the European debt crisis deepens and investors pile into the world’s reserve currency.
At 62.2 percent, the share of global foreign-exchange reserves denominated in dollars is more than double the 24.9 percent for the second-place euro, according to International Monetary Fund data. The percentage of dollar global reserves is the highest since the third quarter of 2010, after falling to a record 60.5 percent in mid-2011.
The euro’s share was the lowest since the third quarter in 2006. The category of “other currencies,” which excludes the yen, dollar, euro, Swiss franc and British pound, shrank for the first time since the start of 2009.
The Dollar Index, which tracks the currency against the euro, yen, pound, Canadian dollar, Swedish krona and Swiss franc, climbed to a two-year high of 84.10 last week as Spanish bond yields rose to records.
The euro fell 0.5 percent to $1.2259 at 3:24 a.m. in New York. It gained 1.4 percent last week as European Central Bank President Mario Draghi pledged to support the sovereign bond market. The dollar dropped 0.3 percent to 78.16 yen today.
Europe’s sovereign-debt crisis prompted the 10 largest U.S. money market funds to cut assets held in debt of euro-region banks in June to 8 percent, a record low, from 31 percent in May 2011, according to a Fitch Ratings study released July 25.
“Fund managers in the U.S. at the moment are clearly again more worried about what’s going on in the global outlook and that’s why they’re stopping sending money abroad,” Mansoor Mohi-uddin, managing director of foreign-exchange strategy for UBS in Singapore, said in a July 25 interview.
UBS expects the dollar to strengthen to $1.15 versus the euro and 85 yen by year-end.
Much of the money flowing to the U.S. is going into government bonds. Yields on five-, seven-, 10- and 30-year Treasuries fell to record lows last week. The benchmark 10-year yield dropped to as low as 1.379 percent on July 25.
“Certainly Treasuries are not cheap, but it’s a hedge against bad things,” said Milne, who favors the government securities along with U.S. investment-grade corporate bonds and mortgages. With the spreading European debt turmoil, “there no longer seemed to be buying opportunities,” he said. “The bad news was no longer a green light.”
The rally in the dollar sparked by Europe’s debt crisis reminds investors of the periods after the collapse of Lehman and the demise of Greenwich, Connecticut-based LTCM. The Dollar Index rallied more than 18 percent from the beginning of 1997 through mid-1999 and 27 percent between the low in 2008 and 2009’s high.
LTCM, led by John Meriwether, roiled global markets when it collapsed in 1998 after losing more than 90 percent of its $4.8 billion of assets in the weeks following Russia’s currency devaluation and bond default. The Federal Reserve orchestrated a $3.6 billion bailout by the fund’s 14 banks to calm fears that the firm’s lenders and trading partners would be dragged down.
This year, dollar gains are being fueled by money coming home from all over the world.
The majority of selling by funds in the five months ended May 31 had been assets of Asian countries, as traders exited bets that saw the Bloomberg-JPMorgan Asian Currency Index gain 19 percent from March 2009 through August 2011. The gauge, which measures the dollar’s performance against major Asian currencies excluding the yen, has since slipped more than 4 percent.
U.S. investors dumped $15.8 billion in assets from Asia this year, according to Treasury data.
“The period when there was heavy diversification into foreign markets between 2005 and 2007 and then after 2009, those flows were to Asia so that’s why we’re getting the most repatriation from there,” Derek Halpenny, European head of currency research at Bank of Tokyo-Mitsubishi in London, said in a July 24 interview.
Bank of Tokyo-Mitsubishi expects the Dollar Index to rise to 86.5 in three months and 87.6 by year-end, which would be its highest level since June 2010.
U.S. investors in May focused on moving assets from the euro zone, selling $4.1 billion more securities than they bought, for the first time since the third quarter of 2011, Treasury data show. That accounted for the majority of net repatriation by domestic investors in May. Bets are surging that Greece will depart the currency bloc as it struggles to meet bailout targets and Germany and other euro-area states indicate a reluctance to put up more funds.
Citigroup Inc. places the probability the nation will exit the euro in the next 18 months at 90 percent and Moody’s Investors Service cited “increased likelihood” of a Greek exit in its decision to cut its outlook last week to “negative” for AAA rated Germany and the Netherlands. The ratings company said in its Credit Outlook today that the ECB’s actions alone “will not resolve the debt crisis.”
“The crisis in Europe will get worse before it gets better and if Greece were to leave the euro zone we could be in a similar-type phase in terms of repatriation flows that we saw in the aftermath of the collapse of Lehman,” Halpenny said.
The euro and stocks recovered at the end of last week as two central bank officials said Draghi will hold talks with Bundesbank President Jens Weidmann in an effort to overcome the stumbling blocks to new measures including bond purchases.
Having secured the backing of governments in Spain, France and Germany, Draghi is seeking to win over ECB policy makers for a multi-pronged approach to reduce bond yields in countries such as Spain and Italy, the officials said late July 27 on condition of anonymity because the talks are private.
Even after its gains, the dollar remains undervalued against its major counterparts. The Fed’s Trade-Weighted Real Broad Dollar Index, which tracks the dollar on a trade-weighted basis versus 38 peers, shows the greenback has depreciated 14 percent from its average in 1973, the year global currencies began freely floating.
The U.S. currency is 37 percent undervalued versus the Australian dollar and 27 percent too cheap against the yen, according to Organization for Economic Co-operation and Development data based on purchasing power.
“As the situation in Europe deteriorates you’re seeing economies around the world slow down,” Bob Gelfond, chief executive officer of global macro hedge-fund MQS Management in New York, said July 24 in a telephone interview. “People will continue to look for safety, and particularly U.S. bonds are viewed as the safest thing out there, which means buying dollars.”
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