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Morning Briefing

Investment Flows

5th April, 2003


Dear Readers,

We were running through some numbers provided by an investment bank today to see whether anything could be made out for the coming months, seeing that we are currently in a period of flux. Your comments and questions are welcome.

Analysis of Investment Flows show the following:
1) In Dec-02 and Jan-03, net foreign inflows into USA (at $37.7 bln and $ 34.7 bln) respectively, were substantially lower than the monthly US Current Account Deficit of $40 bln.
2) While Gross foreign inflows into the USA were at $45 bln (Dec-02) and $42.1 bln (Jan-03), there was a huge purchase of overseas assets by US investors to the tune of almost $7.3 bln in each month, compared to the 12-month averge of $1.7 bln. This is rather remarkable.
3) Even the Gross foreign inflows in Dec-02 ($45 bln) and Jan-03 ($42.1 bln) were lower than the 12-month average of $ 48.1 bln. These 3 readings together show that overseas investors are buying fewer US assets and even US investors are shifting money overseas. The monthly purchase of US assets does not cover the monthly US CAD anymore.


Deeper analysis of flows shows that
1) US investors are selling US equities and buying substantially more overseas assets, especially European equities. Interestingly, EU is selling EU equities and buying Japanese equities, whereas the Japanese are selling Japanese equities and buying US equities. So there seems to be a bit passing the parcel/ merry go round there. No clear trend emerges from this, except that in each region/ country investors are selling domestic equities.
2) Although foreigners have been selling US equities to an extent, they've also been buying US Treasuries (Japan) and US Corporate Bonds (Europeans). Japan still seems to favour US assets, Europeans less so. These readings are based on data upto Jan-03. We need to see how the latest rally in US Equities (coinciding with the advance to Baghdad) effects (or is effected by) portfolio flows.


Looking at speculative market positioning of the IMM upto 25-Mar shows that
1) Euro speculative Longs are at their lowest level in 1 year, with USD Short positions reduced substantially from $14.4 bln to $2.4 bln in a matter of 2 weeks. This means that in case EURUSD starts moving up again, the upmove could be sustainable/ substantial as the speculative Longs are built up again. Conversely, if the speculative community goes Short on EURUSD, then the fall also could be substantial.
2) In USDJPY, market positioning changed from substantial Short positions seen over the last few months to a modest Long position in USDJPY.
3) Short USDCAD positions are still huge. Thus, any reductions in these Short positions could see USDCAD rise substantially

There are 2 things to be watched hereafter:
#1....could the change in positioning from Short USDJPY to Long USDJPY be a leader for a similar change in positioning from Long EURUSD to Short EURUSD in the months ahead?
#2....could the market stay Long USDJPY as well as Long EURUSD, in which case EURJPY would be the biggest gainer, as had happened in Q4-01?

One thing is clear from the IMM data, though, which is that speculative positions have been substantially pared down and are close to neutral. Hence, once the current uncertainty regarding the war is reduced, a big move could start either in favour of the Dollar or against it.


Synthesis
--------------

Global as well as US investors are less enamoured of US assets. With the US economy being weak apart from the war effect, there are chances that the disenchantment with US assets will remain strong. Currently investors across the globe are shunning equities and moving to bonds. If there is a reduction in the holding of US T-Bonds also, the Dollar could suffer. Unfortunately, there is no clear investment alternative, other than Gold (and by implication EUR and AUD). Since the speculative community is almost neutral, a decent size move could be shaping up once the current uncertainty goes away. As there is little doubt that the US will prevail militarily, there could well be chances of the EUR losing towards 1.03-02. But once the euphoria cools down and the business community starts to look at the problems (political and financial) associated with the running and rebuilding of post-war Iraq, the EUR could start moving up again, with global investors seeing 1.03-1.02 as bargain prices for the Euro. The corresponding levels in Swiss Franc would be 1.44-1.45. As for Yen, with BOJ resolute in providing a floor near 117 over the past several weeks, the market could enter a new trading range of 120-125
 
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