October 12, 2003	Sunday	Sha'aban 15, 1424

NEW YORK, Oct 11: The allure Japanese equities hold for foreign investors is a main catalyst for the yen’s surge that shows little sign of abating, proprietary data from some US-based banks indicates.

Portfolio flows into Japanese stocks over the past five months as the world’s second biggest economy picked up the pace have helped drive the yen to three-year highs against the dollar.

Moreover, waning demand among some foreign investors is threatening to decelerate inflows into dollar-denominated assets, thereby eroding the greenback’s support more dramatically.

Robust net inflows to Japan are also taking a toll on the euro against the yen, US-based analysts said.

We continued to see ... net inflows into Japanese equities ... this week and it is providing some very significant support for the yen, said Michael Woolfolk, currency strategist with the Bank of New York, a major custodian bank.

Japan’s benchmark Nikkei average stock index has rebounded by some 34 per cent from two-decade lows in April.

Those inflows to Japan, which started to become pronounced in May, have not let up since.

A recent catalyst accelerating these inflows into Japan was the communique issued by the Group of Seven leading industrialized nations in September that called for more flexible exchange rates, Woolfolk said.

Foreign exchange traders interpreted that statement as an implicit dig at Japan and China to tone down systematic efforts to keep their currencies artificially weak.

In Japan’s case, the market’s reaction in G7’s aftermath has pushed the yen to a series of three-year highs against the dollar.

Despite US Treasury Secretary John Snow’s insistence since the G7 meeting that the so-called “strong dollar” policy remains intact, global investors, by stepping up their sales of dollar-denominated assets, have expressed their belief that the communique put the nails in that policy’s coffin.

Following the G7 statement, according to our flow of funds data, foreign investors turned into net sellers of both US equities and bonds, said Mustafa Caglayan, global foreign exchange strategist with JP Morgan in New York.

During late September, portfolio outflows from the US reached the largest level since mid-2001, showing some adverse effects of the implied shift to the weak dollar policy by the US administration, Caglayan said.

Those portfolio outflows from dollars were at their most intense between Sept 22 and Sept 26, in the immediate aftermath of the G7 statement, Caglayan said.

Although US equities’ push to 16-month highs on Thursday may herald a renewed bid among foreigners for dollar-denominated stocks, demand for US bonds may be waning according to some bank analysts.

Most importantly for the dollar, we have seen a decline in foreign purchasing of US fixed income, over about the past week in Bank of New York’s proprietary data, said Woolfolk.

The volume of cross-border fixed income flows triples or quadruples that of equities, making any deceleration of foreign demand for US bonds a hefty potential liability for the dollar, Woolfolk argued.

Global investors often hedge fixed income investments to cushion against the effects of currency movements, which in turn reduces the effect of these portfolio flows on currencies. But even allowing for the effect of hedging, a diminished preference for US Treasuries or non-government bonds among foreigners could still weigh heavily on the greenback.

For sure, there is a countervailing dollar-positive factor of Japan’s hefty dollar-buying interventions, funds from which are often parked in the Treasury mar-ket.

The Federal Reserve said on Thursday its holdings of Treasuries and agency debt for foreign central banks rose a hefty $18.2 billion to a record $991.77 billion as of Wednesday Oct. 8 compared to the prior Wednesday. That’s an eyebrow raising amount of foreign holdings, coming close to the psychologically important $1 trillion dollar mark.

Nevertheless, there is a potentially even more compelling dollar-negative factor at work. Some banks cite signs that private sector Japanese investors are becoming less enamored of foreign bonds.

Sales of euro zone fixed income by Japanese investors are hurting the euro against the yen, Woolfolk said.—Reuters