Asset flow tug-of-war to buoy dollar until Q1 '09

By Jamie McGeever - Analysis

LONDON (Reuters) - The dollar is expected to remain buoyant into early next year in a global tug-of-war between investors repatriating trillions of dollars of foreign assets and the attraction of U.S. government paper as a safe haven.

While many analysts are increasingly wary of what happens to the dollar once a stress-driven preference for U.S. Treasury debt, deleveraging and capital preservation subsides, most agree the process has further to run.

This essentially "forced" flow of money has meant the fate of the dollar has become closely linked to the intensity of the financial storm. Take a punt on the timing of the crisis peak and you will also probably bet on the dollar cresting.

With the Federal Reserve adopting an aggressive policy of quantitative monetary easing measures -- printing money in effect -- the dollar outlook for later in 2009 looks darker.

But as long as the financial world remains in turmoil, there's potential for billions of dollars to be channeled back into U.S. cash as the scramble for dollars from both U.S. and overseas investors continues, albeit at a slower pace.

An analysis by Swiss bank UBS shows that the proportion of foreign assets held in the portfolios of U.S. mutual funds fell to 22.5 percent at the end of October from a peak of 26 percent a few months earlier.

"Repatriation has also been evident (in) the share of foreign assets falling faster than can be accounted for by exchange rate or global market changes. If investors remain risk-averse in coming months as we expect, the scope for further repatriation and therefore dollar support still remains significant," said Mansoor Mohi-uddin, head of FX strategy at UBS in Zurich.

Mutual funds' foreign market holdings in the last decade bottomed at around 13 percent of their portfolios in early 1999 and in mid-2002, UBS charts show.

The total value of U.S. mutual funds is thought to exceed $6 trillion.

Michael Hart, head of FX strategy for Europe at Citigroup in London, estimated that U.S. investors put around $1 trillion into foreign assets over the past three years, suggesting there's more leeway to bring money home.

"We're in a tug-of-war between U.S. risk-averse investors repatriating capital and foreign risk-averse investors shedding U.S. assets. It seems to me that U.S. flows could (still) outweigh foreigners'" repatriation flows, Hart said.

EURO AT $1.15?

The dollar surged around 17 percent against a basket of six major currencies .DXY between the end of July and last week.

The bulk of that rally came after the collapse of Lehman Brothers in early September triggered a critical phase in the global financial downturn and a worldwide scramble for dollars to cover exposure to U.S. assets, meet dollar funding requirements or U.S. repatriation.

The latest official figures from the U.S. Treasury show that foreign investors plowed a whopping $143.4 billion into U.S. securities in September, the largest in nearly three years and easily enough to cover that month's $56.47 billion trade gap.