Central banks rebuilding foreign-exchange reserves at thefastest pace since 2004 are crowding out private investors seekingU.S. dollars, boosting demand even as the Federal Reserve considersprinting more currency.

After falling to an all-time low of 60.5 percent in the secondquarter of last year, the dollar's share of global reserves rose1.6 percentage points to 62.1 percent in December, the latestInternational Monetary Fund figures show. The buying has left theprivate sector with $2 trillion less than it needs, according toinvestment-flow data by Morgan Stanley, which sees the dollargaining 8.2 percent in 2012, the most in seven years.

While the Fed has created more than $2 trillion under itsstimulus programs since 2008, the flows signal that there mayactually be a shortage of dollars to meet demand as Europe's debtcrisis deepens and the global economy slows. The dollar has risen3.5 percent since the end of April against a basket of themost-widely traded currencies even amid speculation that the Fed,which meets this week, may undertake the type of stimulus measuresthat weakened it in the past.

“The market often assumes that people are long dollars, but manyof those dollars are held by central banks, which are unlikely tomove out,” Ian Stannard, head of European currency strategy atMorgan Stanley in London, said in a June 13 interview. “That leavesus with the private sector, which is short,” meaning they don'thave enough of them, he said. “In an environment where we see aglobal slowdown, the dollar will be well supported.”

Morgan Stanley says the potential scarcity of dollars amongforeign private borrowers represents the U.S.'s net position withlenders abroad of minus $2.4 trillion, adding $4.8 trillion of U.S.financial assets held by central banks, and subtracting $500billion of foreign official assets held by the U.S.

That equals about $2 trillion of demand from foreign privatebanks and companies. The gap has expanded from $400 billion in2008, according to the New York-based firm. In 2002, there was adollar surplus of $900 billion, the data show.

“We expect the dollar to continue to strengthen in the comingmonths on risk aversion stemming from the euro crisis,” strategistsat the investment banking unit of Charlotte, North Carolina-basedBank of America Corp., wrote in a research report dated June15.

Buying Opportunity

The dollar extended last week's 1 percent drop against the euroas projections indicated politicians who support Greece's bailoutwon enough seats in elections to control parliament, easing concernthe nation would be forced out of the euro bloc.

The greenback weakened 0.2 percent to $1.2658 per euro at 9:10a.m. London time, trimming its gain over the past three months to 4percent. It was 0.6 percent higher versus the yen at 79.22. Japan'scurrency is the only major one that has appreciated against thedollar this quarter, data compiled by Bloomberg show.

The decline is an opportunity to buy, according to Stannard andBarclays Plc. Morgan Stanley sees the dollar at $1.19 per euro byyear-end, from $1.2961 on Dec. 30, Stannard said. That would be thebiggest annual advance since the dollar surged about 14 percent in2005. Barclays, based in London, also forecasts the U.S. currencywill finish the year at $1.19.

Strategists have raised their year-end estimates for the dollaragainst the euro by about 4 percent since April, to $1.25, afterholding it at $1.30 for every day but two during the first fourmonths of the year, according to the median of 55 forecastscompiled by Bloomberg.

Aggregate bets the dollar will strengthen against the euro, theyen, the Australian, Canadian and New Zealand dollars, the pound,the Swiss franc and the Mexican peso totaled 301,021 contracts asof June 12, according to Washington-based Commodity Futures TradingCommission data compiled by Bloomberg.

The record of 311,052 was set a week earlier, and compares witha net 17,592 contracts betting on weakness as of May 1.

The dollar is being sought as Europe's leaders struggle toresolve the fiscal turmoil that began almost three years ago inGreece and spread across the 17-nation currency bloc, prompting thenation along with Ireland, Portugal and Spain to requestinternational aid.

Greece's largest pro-bailout parties, New Democracy and Pasok,won enough seats to forge a parliamentary majority, officialprojections showed after yesterday's election.

Spanish Yield

Spain's 10-year bond yield surged to a euro-era record 6.998percent on June 14, less than a week after the fourth-largest euromember requested a 100 billion-euro ($127 billion) bailout for itsbanks. The similar-maturity Italian yield rose to 6.342 percent,the highest since Jan. 20.

Deposits held by foreign lenders at the Fed climbed to $864billion at the end of May, central bank data show. That's the mostsince October 2011 and more than twice the amount in September2009, before a new Greek government sparked the debt crisis bydisclosing a budget gap that was about twice what the previousadministration had declared.

For Michael Sneyd, a currency strategist at BNP Paribas SA inLondon, the dollar will be the most vulnerable among the Group of10 currencies as the economy slows and monetary easing by centralbanks around the world boosts demand for higher- yieldingalternatives.

“We expect further policy easing and further fiscal easing inChina, which will improve the outlook for China and Asia,” Sneydsaid in a June 13 phone interview. “The levels of stress willreduce and so there won't be a shortage of dollars.”

Industrial production in the U.S. fell 0.1 in May as factoriesturned out fewer vehicles and consumer goods, the Fed said on June15 in Washington. Economists forecast a 0.1 percent gain, accordingto the median estimate in a Bloomberg survey. Claims for joblessbenefits rose by 6,000 to 386,000 in the week ended June 9, LaborDepartment figures showed the day before. Economists had projecteda drop to 375,000.

The People's Bank of China cut borrowing costs for the firsttime since 2008 on June 8, lowering the one-year lending rate to6.31 percent, to counter a deepening slowdown. Brazil reduced itsbenchmark rate to a record 8.5 percent on May 31, and signaled itwill cut more to revive growth.

The IMF said on April 17 that world growth would slow to 3.5percent in 2012 from 3.9 percent last year.

While the dollar may appreciate to less than $1.25 per euro inthe next three months, the gains probably won't last as attentionturns to the U.S. fiscal position, said Marcus Hettinger, acurrency strategist at Credit Suisse Group AG.

'Shift Away'

“The risk is that the focus could shift away from Europe,”Hettinger, who's based in Zurich and expects the dollar to end theyear at current levels against the euro, said in a telephoneinterview on June 15. “The U.S. has a budget deficit that needs tobe financed with capital inflows and U.S. interest rates are verylow.”

The U.S. budget deficit will be 8.1 percent of gross domesticproduct this year, compared with 3.2 percent for the euro bloc,according to April projections from the Washington- based IMF. TheEuropean Central Bank's main rate of 1 percent is 0.75 percentagepoint more than the upper limit of the Fed's benchmark rate, whichhas been in place since December 2008.

The dollar may find support as U.S. investor appetite forforeign holdings diminishes while nations add stimulus and globalgrowth slows. The currency has gained 2.7 percent in the past threemonths, which along with the pound is the biggest increase afterthe yen among 10 developed-market counterparts tracked by BloombergCorrelation-Weighted Indexes. The euro slipped 1.4 percent in theperiod.

Brazil boosted its holdings of U.S. Treasuries 19 percent in theyear through April, according to the Treasury. The nation's financeminister spoke of a “currency war” in September 2010 as the realclimbed against the greenback amid the Fed's asset-purchaseprogram, known as quantitative easing, or QE.

Signs of dollar scarcity are manifesting in corporate debtmarkets.

Henkel AG, a Dusseldorf, Germany-based maker of industrialadhesives, signed a five-year, 800 million-euro revolving credit inMarch that charges a 50 basis-point premium if the loan facility isdrawn from in dollars, in addition to the standard 40 basis-pointmargin for other currencies, Bloomberg data show.

U.S. Growth

Paris-based Pernod Ricard SA, the maker of Chivas Regal, wouldhave to offer a higher interest margin borrowing in dollars on afive-year 2.5 billion-euro credit line, two people with knowledgeof the transaction said on April 4. They asked not to be identifiedbecause the terms hadn't been set.

Growth in the U.S. picked up amid the Fed's two rounds of QE,when it bought $2.3 trillion of bonds from December 2008 to June2011. The dollar fell against all of its 16 major peers in theperiod.

After expanding at a faster pace than its major peers the pasttwo years, GDP will grow 2.2 percent this year, compared with anaverage 1.32 percent in the G-10, according to Bloomberg surveys ofeconomists.

“We are bullish dollar because the U.S. economy is in OK shape,we don't think they will do another round of QE and global riskappetite will remain muted,” Paul Robinson, London- based globalhead of foreign-exchange research at Barclays, said in a June 15phone interview.

A survey of 95 global fixed income money managers from the U.K.,Europe, Japan and the U.S. showed that they held the most dollarsrelative to benchmark indexes since the study started in May 1989,Bank of America strategists said in a June 10 report.

That's even as a separate survey by Bank of America showed that44 percent of respondents who do business with the bank predict theFed will undertake a third round of QE within the next four months,up from 31 percent in May.

Weekly cumulative inflows into Treasuries last week werestronger than the five-day average over the past year, according toBank of New York Mellon Corp. customer flow data. Fixed- incomesecurities in Italy and Spain saw outflows, while inflows intoGerman debt were lower than average, according to the bank.

The U.S. currency will remain a haven until the situation inEurope is sorted out, Michael Woolfolk, a senior currencystrategist at Bank of New York, said in a June 13 interview, whenhe predicted the dollar will strengthen to $1.17 per euro in threemonths.

“The only chance that the dollar has for any sustained weakness,other than an occasional daily correction, is for a resolution ofthe Greek debt crisis,” he said.

Bloomberg News

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