ORLANDO, Florida, June 3 (Reuters) - TRADING DAY

Making sense of the forces driving global markets

By Jamie McGeever, Markets Columnist

Stocks and the dollar rose solidly on Tuesday even though

markets lacked a central, driving force - signs of weakening

economic activity, cooling labor markets and disinflation are

all reasons for caution, but risk appetite continues to be

fueled by hopes that U.S.-China trade tensions will soon ease.

In my column today I look at why foreign investors' exposure

to U.S. assets may not be as high as feared. If it's not, the

potential downside for Wall Street and Treasuries from

diversification may be less severe. More on that below, but

first, a roundup of the main market moves.

If you have more time to read, here are a few articles I

recommend to help you make sense of what happened in markets

today.

1. Markets anxious as 'new cold war' turns hot: Mike

Dolan

2. FX options market positioned for further dollar

weakness

3. OECD lowers global outlook as Trump trade war

hits U.S.

growth

4. Japan to promote domestic ownership of JGBs,

policy

draft shows

5. G7 debt is now a pressure point for anxious

markets

Today's Key Market Moves

* The S&P 500 hits a three-month high, rising 0.6% on the

day, and

the Nasdaq hits its highest level since February after a 0.7%

rise.

* The dollar rebounds 0.6%, but only after plumbing

a

fresh six-week low. It gains most vs yen, Swiss franc and

Swedish krona, up 1% against all three.

* One of the quietest days in weeks for the U.S. bond

market, with

the 10- and 30-year yields recording their smallest moves since

May 9. Each barely moves a basis point.

* Oil rises for a second day, with Brent and WTI

futures

up around 2%, on geopolitical tensions and supply worries.

* Gold slips almost 1% but earlier in the day hits

$3,392/oz, its highest since May 8.

Market inflection points abound

Evidence is mounting that global economic activity is

slowing, but this is failing to move the dial much for markets.

Investors know growth is slowing and that the second half of the

year will be challenging, so that's already 'in the price'.

Hopes of a de-escalation in the trade standoff between the

U.S. and China, and for bilateral deals between the U.S. and

other key trading partners soon are supporting risk assets.

The S&P 500 hit a three-month high on Tuesday, while the

Nasdaq and MSCI World index climbed to levels last visited in

February. It is the strength on Wall Street, most latterly tech,

that is lifting global stocks as benchmark Asian and European

indices are flatlining.

On the whole, policymakers continue to stress that they are

data-dependent and will move on rates carefully and calmly. That

was the message from various Fed officials this week and Bank of

England Governor Andrew Bailey on Tuesday.

It's a slightly different - although no less challenging -

situation in mainland Europe, where figures on Tuesday showed

disinflationary forces are driving consumer prices as much as

anything else.

Euro zone inflation dipped below the European Central Bank's

2% target in May, cementing expectations rates will be cut this

week and later this year. Meanwhile, Switzerland experienced

outright year-on-year deflation for the first time in four

years, raising the possibility that the Swiss National Bank may

soon reintroduce negative interest rates.

Canada's central bank is expected to hold interest rates at

2.75% on Wednesday for a second meeting. Growth and inflation

have been surprisingly sticky this year, and rates have been

slashed by 225 basis points since last June.

As UBS analysts note, markets are generally at an inflection

point, waiting for the catalyst that will break them out of the

narrow ranges that have broadly held since the U.S. and China

announced a temporary reduction on tariffs on May 12. Even Wall

Street and the dollar - one creeping higher, the other drifting

lower - are awaiting a trigger for a proper breakout.

Could the telephone call between U.S. President Donald Trump

and Chinese leader Xi Jinping expected later this week be it?

Foreign exposure to U.S. assets may be lower than feared

It is widely believed that investors around the world have a

disproportionately high exposure to U.S. assets, particularly

stocks, an imbalance that could roil U.S. markets if corrected.

But what if these fears are overblown?

Several eye-popping statistics suggest that America's weight

in world financial markets is even greater than its outsized

economic might. Most strikingly, the U.S. net international

investment position (NIIP), or foreign investors' holdings of

U.S. assets less U.S. investors' holdings of overseas assets, at

the end of 2024 was $26 trillion. That's nearly 24% of global

GDP, up from 16% only two years earlier, a surge driven by

foreigners' insatiable appetite for U.S. equities, mainly "Big

Tech".

Demand was so hot that, by some measures, the value of

U.S.-listed stocks at the turn of the year represented 74% of

total global market cap. That share was 60% six years ago, and

less than half in 2011.

But the attractiveness of dollar-denominated assets is now

being questioned, as the often erratic policies of U.S.

President Donald Trump have upset longstanding economic and

geopolitical norms, making governments and investors question

whether Washington is still a reliable partner on the global

stage.

The concern is that this eroding confidence triggers a

reversal of the massive flows into Wall Street seen in recent

years that has damaging spillover effects.

Such a correction may not require outright selling. Given

the scale of the flows involved, just less buying among foreign

investors could be enough to cast a shadow over the world's most

important stock market.

And the running assumption is foreign investors don't have

the capacity or willingness to increase their exposure to U.S.

assets, creating a significant long-term downside risk for Wall

Street, Treasuries and the dollar.

"A structural shift is underway: the slow erosion of US

economic dominance," analysts at Deutsche Bank wrote on Monday.

SKEPTICAL

But looked at another way, foreign exposure to U.S. assets

may not be as high as initially meets the eye. That's the view

of analysts at JP Morgan, who measure portfolio investment in

U.S. bonds and equities as a share of countries' total household

sector financial assets.

They use a broad definition for a country's "household"

sector, covering investments by institutions like insurance

companies and pension funds that are ultimately made on behalf

of households. Using a broad range of data, from central banks,

U.S. Treasury and OECD household financial asset flows, they

measure the ratio of U.S. equity and bond holdings relative to

household financial assets in each country.

They find that "relative to the total financial assets of

households in the rest of the world, the allocations to U.S.

assets typically stand at around 10-20%." As a result, they are

"skeptical of the idea that foreign investors hold too much of

U.S. assets."

Given that U.S. equities account for more than 70% of the

MSCI global market cap and dollar-denominated bonds represent

around 50% of global bond indices, according to JP Morgan

estimates, the 10-20% exposure of foreign investors to U.S.

assets does appear surprisingly low.

And the 10-20% figure would be even lower were it not for

the outsized U.S. equity holdings at the Swiss National Bank and

Norway's sovereign wealth fund.

On the bond side, foreigners' footprint in the U.S. Treasury

market is shrinking. Data shows that they owned 31% of the

$28.55 trillion outstanding Treasury debt at the end of last

year. That share has been declining steadily since the Global

Financial Crisis. In 2008, the figure was approaching 60%.

Overseas investors' share of the T-bill market has shrunk

even more. In December, it was under 20%, near its lowest level

on record and sharply down from 50% a decade before.

Nikolaos Panigirtzoglou and his team at JP Morgan aren't

arguing investors will or should ramp up their purchases of U.S.

assets. And in cases where allocations are high - such as the

Taiwanese exposure to U.S. bonds or Canadians' holdings of U.S.

stocks - diversification would hardly be a surprise.

But there is "little indication" of broad-based selling of

U.S. assets by foreign investors so far this year, they note.

And if that selling does materialize, it may be far lighter than

many expect.

What could move markets tomorrow?

* Australia GDP (Q1)

* South Korea inflation (May)

* South Korea GDP (Q1, revised)

* UK services PMI (May)

* Canada interest rate decision

* U.S. services ISM (May)

* U.S. ADP employment (May)

* Federal Reserve releases Beige Book

Opinions expressed are those of the author. They do not

reflect the views of Reuters News, which, under the Trust

Principles, is committed to integrity, independence, and freedom

from bias.