Asia's Shift Away from the US Dollar; Japan the Final Shoe to Drop

Fed Fund futures are discounting a further rate cut of some 50bps on April 30, which would take the FF rate to 1.75%, or only 75bps from the historical low of 1.00% set in 2003 amidst the deflation scare. This could very well push 10YR TB yields back to 2003 lows.

Given that the Fed’s unprecedented countermeasures are still not addressing the root of the problem, i.e., imploding housing and real estate prices, any reversal in the USD’s slide is likely to be temporary, and the direction of the CBOE 10Yr TB yield index is still very much south.

It is one thing to hear Iran and Venezuela railing against the US and asking trading partners like Japan to pay for oil imports in Yen, and quite another to learn that South Korea’s National Pension Service [NPS], which is the world’s fifth-largest pension fund with $220bn in assets and a traditional buyer of US treasuries, say they are finding it difficult to buy more US Treasuries due to already large exposure and plunging yields.

The 500-pound gorillas in terms of foreign holders of US treasuries are Japan and China, whose holdings of $587 billion and $493 billion respectively are a full 45% of all foreign holdings and 64% of “official” foreign holdings of US treasuries.

As China has been making noises about diversifying away from the US dollar for some time, the last shoe to drop would be Japan, where USD holdings account for a full 60% of total foreign exchange reserves of some $979 billion. But even Japan is beginning to seriously debate the formation of a sovereign wealth fund.

Assuming a USD-based investor went long JPY versus USD in June 2007 and at the same time shorted the Nikkei 225, they would be sitting on a total gain of some 50% despite all of the credit market turmoil. This same trade could see another 50% as JPY surges to JPY79/USD, while the Nikkei 225 slides to 10,000.

Or, this same USD investor could have simply bought gold, which has gained 59% during the same period, and could go to $1,500/ounce under the above scenario, for an additional gain of some 50%.

Comments

[Philly Jim]

Japan won't dump the dollar anytime soon, they are smarter than that. They don't let new money make them delusional as seems to be the case for 3/4 the planet. You think they sleep well at night knowing that China is set to outpace the U.S. military in terms of projected regional military capabilities? How about North Korea firing off those short-range nuclear capable missiles when Kim Jung thinks someone call him a bad name? People really need to wake-up from this state of delusion new money has put them in. It is beyond my comprehension that leaders in the U.S. have allowed decades of U.S. dollars to flow to their most feared enemies in terms of oil and junk imports. Obviously they don't look beyond the 10 year window or they would have seen China upstaging the U.S. military and the Jihadists building an financial empire on oil money. The only case I see for abandoning the U.S. is the fact that the country is being destroyed from within as the demographics and education system deteriorates into something akin to that seen in "third-world"... nations.

[Kunst]

Tomorrow Bernanke will reassuringly say that things are starting to look better. That means less chance of a rate cut and may or may not boost the stock market.

Of course, it has no relation to reality one way or the other, but who cares about that?