NEW YORK (CNN/Money) -
It's official: Japan spent far and away more money in January shoring up the dollar than ever before. Given recent developments, it's something that should make Treasury investors worry.
Friday, the Bank of Japan said it sold ¥7.15 trillion ($68 billion at current rates) in the currency market from Dec. 27 through last Wednesday to prevent the currency from getting too strong and hurting exports. To get an idea of the scope of this, consider that through all of 2003, a year when Japan intervened in the currency markets like never before, the BOJ sold ¥20 trillion.
If past is prologue, we know that a lot of the dollars the BOJ bought got parked in U.S. Treasurys, as did the dollar purchases of other Asian central banks, notably China's. What's really striking is that through the period we're talking about, Treasurys traded in a tight range. If it hadn't been for central bank buying, one imagines that Treasury prices might have fallen, pushing yields considerably higher than they are now.
Enter Alan Greenspan.
The dollar dynamic has changed, however, ever since the Fed's change of tone following its meeting this week caught the market wrong footed. The Fed's suggestion Wednesday that it might someday raise rates sparked a sharp reversal in the dollar. Down in early trading, it was up strongly against other major currencies late in the day. That trend continued through Thursday.
Why did this happen? Teasing out the relation between currency movements and interest rate decisions can be a bit messy, but here goes.
To begin with, a standard theory on interest rates is that the higher they are in a country, the more attractive its currency is, on account of higher returns.
A corollary to this is that the higher rates go, the less attractive a currency is for financing investments elsewhere. It's another example of what's called a carry trade -- borrow at low rates in the United States, park your money in places with higher rates of return, like South Africa. This is a game that, thanks to the proliferation of various online accounts, even some individuals appear to be playing. (Folks, that ranks right up there with home dentistry, but we digress.)
Another reason the Fed's somewhat tougher-sounding stance may have strengthened the dollar is that it may come part and parcel with a push to fiscal rectitude. Greenspan's deal with Washington in the 1990s was that if Congress cut the budget deficit, rates could go much lower. Now we're in the realm of expanding budget deficits again, and Greenspan is said to be upset -- according to Fortune he's "gearing up to deliver a tough message on the deficit" to Congress, perhaps at his semiannual testimony next month.
The budget deficit is one of the things that's gotten so many people bearish on the dollar, because they worry that the government will eventually turn to the printing press to pay off its debts; the suggestion that Greenspan may be pushing to reduce it could shore up the buck.
If the forces that have been sending the dollar down have diminished, points out Credit Suisse First Boston bond strategist Mike Cloherty, Japan and other Asian countries won't be purchasing greenbacks -- and thus Treasurys -- like before. Take those big buyers out of the market, and what happens next?
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