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Weak dollar, excess cash help fuel M&A boom

NEW YORK (Reuters) - Global financial markets awash in liquidity, due partly to a weak dollar, have spawned a flurry of mergers and acquisitions this year, and as long as the greenback remains soft the boom has further to run.

A customer counts U.S. banknotes at a money changer in Jakarta August 22, 2005. Global financial markets awash in liquidity, due partly to a weak dollar, have spawned a flurry of mergers and acquisitions this year, and as long as the greenback remains soft the boom has further to run. REUTERS/Beawiharta

The weak dollar, which has been pressured by gloomy U.S. growth expectations and diminishing yield advantage over other major currencies, has triggered huge increases in foreign exchange reserves for countries such as China and Japan that don’t want a soft dollar because it erodes their export competitiveness.

The surge in foreign exchange reserves by global central banks and a robust stock market have ensured lots of cash to fund M&A deals, analysts say. The surplus has kept global interest rates low and made financing of these transactions a lot cheaper.

Rising M&A transactions that tracked increasing global reserves also happened in the mid-to-late 1990s, analysts say.

Data from Dealogic showed that about $4 trillion in global M&A deals were announced in 2006, and since the beginning of the year volumes have totaled roughly more than $2 trillion. M&A activity since January was 60 percent higher than in 2006.

Some of the recent deals include Alcoa's AA.N $27 billion hostile bid for aluminum rival Alcan AL.TO of Canada and a $7.7 billion offer by Sweden's SSAB SSABb.ST for Canadian steel mill operator Ipsco IPS.TO.

“To the extent that you have central banks intervening to keep the value of their currency at a competitive level by accumulating dollar reserves at a rapid pace, that is going to boost liquidity and be one of the factors contributing to M&A activity,” said Nick Bennenbroek, head of currency strategy at Wells Fargo Bank in New York,

When central banks intervene in the foreign exchange market, they buy dollars and sell the local currency to keep their unit weak. These banks, however, try to offset the inflationary impact of the increased local currency in circulation by selling government securities.

But often the accumulated dollars in central banks’ reserves are not fully sterilized and their recycling into the bond market keeps longer-dated yields below their appropriate level.

Bear Stearns chief currency strategist Steve Barrow in London said he doubts very much whether central banks have a lot of influence in controlling liquidity when the dollar is this weak and reserves are this strong.


Barrow said it was no coincidence that global reserves are rising rapidly at a time when global M&A activity is rising sharply.

Global currency reserves climbed to $5 trillion in the last quarter of 2006, about 20 percent higher from a year earlier, according to International Monetary Fund data.

“We believe the liquidity that results from the currency system fuels the strength in asset prices, the strength in global growth and the strength in M&A activity,” Barrow wrote in a research note.

Analysts say the last big merger boom occurred in the mid-to-late 1990s, after a period when global reserves had risen at a fast clip during the mid-1990s and the dollar was as weak as it is today.

IMF data showed that global foreign exchange reserves grew from around $1.3 trillion in 1995 to about $2 trillion at the end of 2000. That coincided with weakness in the dollar index in 1995 when it was just above 80.2, not far from were it is today at 82.0 .DXY.

From 1995-2000, the dollar index gradually gained ground before slipping again in late 1998, a period when M&A deals gathered pace.

Given that there is little to signal global liquidity is drying up, analysts say this enthusiasm for M&A deals still has a long way to go.

Still, some analysts discounted the impact of a weak dollar on the market’s current appetite for M&A transactions. “It’s really about the money -- the tremendous liquidity in debt markets and strong corporate cash flows,” said Avery Shenfeld, senior economist at CIBC World Markets in Toronto.

Market participants are also bullish on M&A prospects in China, which has kept its yuan currency soft at a time when reserves have climbed above $1 trillion.

“The continued availability of low-cost finance on a global basis, coupled with the Chinese economy growing at 11 per annum, will help drive M&A activity in China,” said Dana Schuppert, chief executive officer of Strategic European Investment Management Ltd. in Beijing.