Japan’s banking minister, Shizuka Kamei said, recently told the Financial Times that the government-owned financial conglomerate Japan Post, one of the largest buyers of Japanese government bonds (JGBs), should invest more in corporate bonds and U.S. Treasuries, rather than Japanese government bonds.
This is very important and positive fundamental support for the U.S. dollar and pricing for U.S. Treasuries.
“Nearly 80% of Japan Post Bank's funds go towards buying JGBs, but from now on any increase in deposits could go towards buying corporate bonds . ... and U.S. Treasuries,” Kamei said.
“The U.S. is having difficulty due to a lack of funds. It's only natural that we should support the U.S. when it is weakened, so Japan Post Bank's funds may go towards that."
Mr. Kamei also said he expected deposits at Japan Post to increase “substantially” as a result of a restructuring, which the government is poised to announce this month.
Now, that said, we know that the performance of the euro in relation to the dollar during the past decade has been supported by worldwide foreign exchange diversification.
It’s a fact that most of this diversification has been directed towards the euro zone’s bond markets.
So, let’s take a look at the income flows when considering what to expect for the euro.
It is worth noting that despite Greece’s relatively very small size within Europe, the flows into and out of Greek government bonds have acted as a particularly accurate “acid test” of sentiment toward the euro during the past two months.
The two successive waves of outflows out of Greek government bonds that have occurred since November have unsurprisingly acted as a harbinger to sharp declines in the euro.
By the way, it shouldn’t be overlooked that the outflows we have seen during the past two months from Greek government bonds have been of a similar magnitude to those seen in the run-up to the financial crisis in 2008.
It is also noteworthy that a similar pattern emerges when we look at flows into and out of the Italian bond market, or more tellingly, if we look at our foreign exchange flow data for the euro.
I consider the emergence of these common patterns a cause for concern.
Given this, we should note that we continue to see healthy inflows into the Japanese yen and that the picture for the dollar is also just starting to turn positive again.
In this context, we already saw the dollar index reversing its downward course in December and becoming stronger in January.
Lately, weakness in the euro has been the main catalyst for this move.
Currencies, as well as securities and overall commodities, generally decline simply because of a lack of buyers.
The euro clearly attracted buying interest from March to November 2009.
Recent lack of trust in Greece, Ireland and other European countries caused buyers to withdraw from the euro.
George Soros was recently quoted as saying that there was “no attractive alternative to the dollar.”
Looking at the Euro ETF (FXE), with a lower high and wedge support break over the last two months, it certainly starts beginning to look like a long-term downtrend for the euro and consequently a long-term uptrend for the dollar.
Strength in the dollar is especially impressive because short-term interest rates moved lower during the last four weeks.
Since March 2009 until December, we had seen a positive correlation between the dollar and short-term interest rates both moving lower.
Now, notwithstanding that U.S. short-term rates moved sharply lower the last four weeks, the dollar continued its advance with a surge the last two weeks.
A big cause for the dollar’s upward move has been the weakness of the euro.
The dollar’s Relative Strength Index, or RSI, moved above 70 to become overbought for the second time in two months.
While overbought conditions suggest that the short-term trend is getting overextended, it is bullish for the dollar long-term trend.
The ability to reach overbought levels is a sign of strength, not weakness.
Bottom line: We all know that nothing goes up or down in a straight line.
Therefore, investors who are still overweight in euros could somewhat lighten up in favor of the dollar whenever a small bounce in the euro or pullback in the dollar occurs.
Don’t forget, the Relative Strength Index for the dollar shows “overbought” for the moment.
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