Global investment flows on cusp of major shift

Richard Bernstein gestures as he speaks at the Reuters Investment Outlook Summit in New York June 7, 2010.

NEW YORK (Reuters) - With investors increasingly skittish about emerging markets and U.S. bond yields expected to rise, investment funds could start to flow back to the United States -- a reversal that could boost the U.S. dollar and asset prices.

Signs are cropping up that fund flows already are moving away from their recent norms, and with the Federal Reserve completing its second bond-buying program at the end of June, all the market needs is a catalyst to spark a larger move.

Investment strategists at this week's Reuters 2011 Investment Outlook Summit in New York suggested concerns over China or an unexpected geopolitical event as potential triggers to a reversal in investment flows.

"As investors become more aware of the risks in emerging markets, funds might flow back into the United States and support the dollar," Richard Bernstein, founder of Richard Bernstein Advisors LLC, told the summit.

Bernstein, who declared himself a dollar bull, said a flow of funds back to the United States would be good not only for financial markets but also for the broader economy.

"I think it would be long-term positive for U.S. assets," he said.

China's economy is slowing, and a faster-than-expected drop in its growth rate could trigger a change in flows by central banks and foreign investors.

There is no certainty, however, that a change in flows would accelerate the flow of money into the United States.

Central banks, which have a conservative investment outlook, have been shying away from the dollar, according to Jens Nordvig, global head of G10 FX strategy at Nomura Securities in New York.

Over the past decade about 60 to 65 percent of central bank flows have gone to the United States, Nordvig said. But the flow has recently dropped to around 40 percent, with the Australian and Canadian dollars beneficiaries of that shift.

"If you think about global central bank flow over the last six to nine months there has been a shift that should not be underestimated," Nordvig said at the summit.

"There's now a meaningful under-accumulation of dollars. That is a major, major change," he said, citing data from the Bank for International Settlements, the International Monetary Fund, the U.S. Treasury and the Federal Reserve and other central banks.

The latest Treasury data showed that foreigners cut purchases of long-term U.S. securities in March, the fourth straight monthly decline. The United States attracted a net inflow of long-term capital of $24 billion, down from $27.2 billion in February, data released in May showed.

The accumulation of foreign reserves is significant and could top $1 trillion this year, 85 percent of which will be held by emerging markets, Joyce Chang, head of emerging markets and global credit research at JPMorgan, told the summit.

Seasonal factors could reduce the purchase of Treasuries by foreigners this summer by about a quarter, but central banks have few options when investing their reserves, Chang said.

"There aren't many places it can be deployed and I think that accounts for part of the reason why you've had Treasury yields going down," she said.

Last week the yield on the benchmark 10-year Treasury note fell below 3 percent for the first time since December.

The Fed's unorthodox monetary expansion policy -- dubbed quantitative easing, or QE2 -- has kept short-term rates at record low levels and pumped liquidity into financial markets.

The Fed will have bought about $600 billion in U.S. government debt when QE2 ends June 30. Most summit guests expect Treasury yields to climb in the next six months off of historic lows.

Heavy buying by the largest foreign holders of Treasuries will be needed to avoid a pick-up in yields, Morgan Stanley said in a recent report.

Jane Caron, chief economic strategist at Dwight Asset Management in Burlington, Vermont, noted that the low-rate policy has forced U.S. investors to seek higher returns in emerging markets.

"Is this what the Fed wants?" Caron said." Do they want to drive investors out of the U.S. by depressing local returns only to have this money recycled back to the U.S. in the form of Treasury purchases by foreigners?"

(Reporting by Herbert Lash; Editing by Leslie Adler)