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Weight of speculation seen working more against gold than the dollar

Section: Daily Dispatches

Investors Unite Around Dollar's Decline

By Agnes T. Crane
Dow Jones Newswires
Monday, November 29, 2004

NEW YORK -- A weakening dollar isn't exactly news
for financial markets, but the acceleration of its
decline in recent weeks and the headlines it has
generated have prompted investors ranging from foreign
central banks to mutual funds to question their
allegiance to the buck.

This has direct consequences for dollar-denominated
fixed income assets that have so far weathered the
more than 30-percent decline in its traded-weighted
index since July 2001. It was easier to ignore a
weaker dollar when the Federal Reserve was
lowering short-term interest rates at a breakneck
pace and foreign central banks were gobbling up
U.S. Treasurys and other high-grade U.S.
fixed-income assets as they fought to slow the
decline in the dollar.

But times have changed. The Fed has raised rates
by 100 basis points this year with another 25 basis
points in December likely on the way. Asian central
banks' commitment to a strong dollar as a means
to keep their export engines humming has also
come into question in recent weeks.

The Japanese Ministry of Finance, renowned for its
currency manipulation earlier this year, is nowhere
to be found in foreign exchange markets even though
the dollar has fallen well below Y105. In the first
quarter the Bank of Japan, which acts on behalf of
the government, fiercely defended that level by
spending a record Y14.83 trillion.

George W. Bush's election victory also has brought
sharply into focus such dollar- and bond-negative
factors as the ballooning federal budget deficit and
soaring current account deficit.

Perhaps most telling is that the top U.S. central
banker is talking about it. "The dollar is on the docket
as evidenced of Mr. (Alan) Greenspan speaking up"
about the current account deficit and its corrosive
effect on the U.S. currency when he participated in
a panel discussion earlier this month, said Jack
Malvey, chief global fixed income strategist at
Lehman Brothers in New York.

Foreign central banks, which have beefed up their
dollar holdings in recent years, have started to hint
at diversifying their reserves to lessen exposure to
the currency. Russia's central bank said it plans to
add non-dollar currencies to its reserve mix as
well as replace the ruble's dollar peg with an anchor
based on a basket of currencies.

Meanwhile, an adviser to the People's Bank of China
pointed out Friday that that nation's holdings of
Treasurys have declined as a percentage of foreign
reserves, feeding speculation that the central bank
is also diversifying away from dollars.

"The support and props for the dollar are all being
removed," said Sung Won Sohn, chief economist
at Wells Fargo Bank in New York. Though U.S.
fixed income has sagged little under the weight
of a slumping dollar, "it's only a matter of time
before it does."

In his December outlook piece, influential bond
fund manager Bill Gross of PIMCO advised clients
to position for the inevitable dollar decline and
subsequent higher interest rates.

Some mutual funds are already leaning in that
direction. According to AMG Data Services of
Acata, Calif., which tracks mutual fund flows,
investors are increasingly turning to international
bonds in growing numbers. As of Tuesday, Nov.
23, $1.2 billion, or 15.6 percent, of the $7.7
billion channeled into fixed income, was poured
into international funds during the fourth quarter.
This compares with 5.5 percent in the third quarter.

The fourth quarter inflows, which represent 3.3
percent of total fund assets, are "far away the
most disproportionate inflows in terms of
percentage of assets," said Bob Adler, AMG
president. The group seeing the second largest
inflow is high-yield debt, he added.

Media coverage of the dollar's troubles has become
so pervasive -- spreading from the business pages
to the mainstream press -- that its value against its
major rivals is now fodder for small talk among
friends over cocktails. This doesn't necessarily
mean it's a precursor to an even steeper slide in
the currency. It could just be a matter of catching

"Retail investors tend to react slowly to changes in
markets," said Nic Pifer, head of global fixed
income at American Express Asset Management
in Minneapolis. "It always raises the question of
'has the horse already left the barn?'"

That said, there are few analysts who expect the
dollar to snap back either. The pull of the twin
deficits in the current account and the federal
budget and deep bearish sentiment against the
buck on Wall Street make a comeback any time
soon unlikely.

Foreign central banks, however, still represent a
wild card for both the currency and bond markets.
Though the Bank of Japan hasn't purchased one
dollar since it pulled up its stakes in mid-March,
recent comments from high-ranking officials
suggest it stands ready to spring into action if
the dollar's decline becomes unwelcome.

Moreover, South Korea's monetary authorities are
already snapping up dollars in an effort to re-start
that nation's export-led economic recovery while
China's intransigence over its fixed currency
regime means the central bank must buy dollars
to maintain the yuan peg.

Asian central banks tend to recycle their dollar
proceeds into U.S. Treasurys and other government
securities, which in turn helps keep yields low.

But with the euro already taking the brunt of the
dollar's decline since 2001, all eyes are fixed on
Asia to see if nations there will fight the tide or
succumb to the global pressures and allow buck
to decline.


Agnes T. Crane covers U.S. and global credit
markets for Dow Jones Newswires.


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