By Richard Leong
NEW YORK (Reuters) - The advantage of higher yields in the United States has not prompted foreign buying as investors had expected, and central banks have instead dumped Treasuries in recent months.
Foreign central banks reduced their holdings of U.S. Treasuries last week to $2.900 trillion, the lowest in a year, according to the U.S. Federal Reserve. Thursday will bring new weekly data on this figure, and signals point to flows continuing toward Europe in both equity and fixed-income.
The shift in money out of U.S. assets is unexpected, given that the dollar recently hit a 12-year high and U.S. yields are much higher than Europe's. Analysts believe overseas central banks have spent dollar reserves to defend currency pegs or to stem further depreciation against the greenback.
Overseas central banks sold Treasuries for a third consecutive month in January, and have not ratcheted up their bidding for Treasuries at auctions, Treasury Department data shows.
Some foreign fund managers have decided to chase higher returns in the European stock market rather than piling cash into Treasuries.
"While we do see some foreign purchases of U.S. bonds, a large part of the money is being cycled into equities," said Kathy Lien, managing director at BK Asset Management in New York.
European shares are up 17 percent so far in 2015, as the European Central Bank's 1.1 trillion-euro quantitative easing has boosted risk-taking. Some overseas investors might be hanging on to their European government bonds in hopes of profiting from the QE program, investors said.
This reduces the effectiveness of QE in weakening the euro, which would help regional exporters.
"The challenge for an economy with a current account surplus is that recycling is required to keep the currency down. And with equity inflows outpacing debt outflows, this recycling doesn't seem to be happening," Citi analysts wrote in a research note on Tuesday.
About 50 billion euros went into European equities in January, while roughly 20 billion euros left European debt, according to Citi analysts.
BK's Lien said there is still a lot of foreign cash sitting on the sidelines.
"We need to see a stronger message from the Federal Reserve that they are ready to raise interest rates so we would see yields that would inspire a more aggressive inflow. That may not happen until this summer," Lien said.