Japan to diversify FX reserves?

Japan probably won't be the first to abandon the dollar, but it is obvious that currency markets are jittery.

Bloomberg: The dollar fell to a nine-week low against the euro in Asia after Japanese Prime Minister Junichiro Koizumi said his country "in general'' needs to consider diversifying its foreign currency reserves, the world's largest.

The U.S. currency erased losses against the yen and pared some versus the euro after a Ministry of Finance official said Japan has no plan to make a change, comments echoed by Finance Minister Sadakazu Tanigaki. Japan's official reserve assets totaled $840.6 billion at the end of February, mostly in U.S. Treasuries.

"By saying Japan could diversify its holdings, it's opened a Pandora's Box,'' said Harvinder Kalirai, chief market analyst in Sydney at State Street Corp. ``They can just stop buying Treasuries. It could impact the behavior of other central banks. This is going to weigh heavily on the dollar.''

The dollar dropped to $1.3429 per euro at 1:59 p.m. in Tokyo from $1.3391 late yesterday in New York, according to electronic currency-dealing system EBS. It also traded at 104.08 yen from 103.93. The dollar dropped as low as $1.3455 a euro, the weakest since Jan. 4.

The dollar may fall to a record $1.40 per euro and below 100 yen this year, Kalirai said. State Street is the world's largest custodian of assets, managing more than $1.2 trillion.

Speaking in Parliament, Koizumi said Japan needs to make an "overall judgment'' on how to invest reserves by considering the stability of such investments. Tanigaki later said the comments were made as a general argument and don't mean the government will shift its holdings.

"There's never been a comment from Japan that it might diversify, so the dollar getting sold off is understandable,'' said Robert Rennie, a currency strategist in Sydney at Westpac Banking Corp. Ministry clarifications "helped shore it back up.''

The dollar fell 1.4 percent against the euro and the yen on Feb. 22 after South Korea's central bank announced plans to boost returns by diversifying its currency reserves. The bank later said it wouldn't sell dollars from its current holdings to achieve its goal.

Koizumi's comments pushed U.S. 10-year Treasury yields to the highest in more than seven months. Japan, the largest foreign holder of U.S. Treasuries, owned $711.8 billion of them as of December, and cut its note holdings in three of the last four months of 2004.