Aileen Wang and Simon Rabinovitch

BEIJING — Reuters Published on Tuesday, Jan. 12, 2010 6:52AM EST Last updated on Tuesday, Jan. 12, 2010 7:14AM EST

An investment strategist at China's $300-billion (U.S.) wealth fund said the world's third-largest economy now had a say in the exchange rate of the U.S. dollar, which it expects to rise while the yen should fall further.

The comments by Peng Junming, who works in the asset allocation and strategic research department at China Investment Corp, triggered a rally in the U.S. dollar.

“I think the dollar is at its bottom now. There will be very limited space for the dollar to drop further,” he told an academic forum. “The yen is what, I think, has the worst outlook. The yen will continue to drop, unlike the dollar, which will not serve for long as a source of funding carry trades.”

The U.S. dollar rose more than half a yen close to 92.40 yen on the news, then pared gains after Mr. Peng said his speech at the Chinese Academy of Social Sciences reflected personal views. The euro slid against the dollar and gold dropped before rebounding slightly.

The market reaction to Mr. Peng's comments shows the sensitivity to clues on how China and its state fund view the markets.

“A U.S. government official recently said that the dollar is ours but the problem is China's. But China now has a voice in influencing the dollar's exchange rate and the interest rate on U.S. government debt,” Mr. Peng said.

“Although the dollar belongs to the U.S., China has a role to play in determining the dollar's exchange rate.”

No Need for Gold

Mr. Peng noted that China's stash of dollars enabled it to influence commodities markets. Commodities like oil are priced in dollars and the prices tend to move inversely to the dollar.

“We can weigh down or push up the dollar exchange rate, which will have an impact on the global commodity futures market.”

Mr. Peng was explicit in his view on gold: “China should have the right attitude about investing in gold. There is no urgent need for China to increase gold buying for now, because prices are high.”

He defended U.S. Treasury investments, arguing they had offset losses in stocks and helped swell currency reserves in 2007 and 2008.

About two-thirds of China's reserves, the largest stockpile in the world at $2.27-trillion, are estimated to be invested in dollar assets.

Lou Jiwei, CIC's chairman, has been careful not to say much about how the fund invests its money. In October 2009, he said the fund was putting more money into commodities, real estate and infrastructure to hedge against medium- and long-term inflation and a fall in big currencies.

Mansoor Mohi-uddin, currency strategist at UBS in Singapore, said sovereign wealth funds are returning to prominence after losing influence during the financial crisis.

However, private sector U.S. portfolio managers have the ultimate say on the dollar, he noted.

“The portfolios of both sovereign wealth funds and central banks globally remain dwarfed by U.S. asset managers. It is the latter, as the largest holders of dollars in the world, who will continue to determine the ultimate direction of the greenback,” he said note to clients.

Turning to interest rates, Mr. Peng, who previously worked in the New York office of the Chinese central bank, said he expected that both the United States and China would raise rates in the second half of the year.

Many in the market have assumed that China will wait for the United States to raise rates before doing so out of fear that a bigger rate differential will attract speculative capital, adding more money to the Chinese economy already awash with cash.

But Mr. Peng said that the People's Bank of China may have to move first to raise rates in order to combat asset bubbles at home. Officials have repeatedly warned that property prices are rising too rapidly, but so far have relied largely on land and tax policies to calm the market.

China Investment Corp. was set up in late 2007 with $200-billion hived off from the foreign exchange stockpile, with a mandate of seeking higher returns than the more cautious reserve management agency.

Thanks largely to investments in domestic banks, its assets under management reached $300-billion at the end of 2008.

Chinese media have reported that CIC might be in line to receive as much as $200-billion extra from the foreign currency pot.

Mr. Peng said he had heard that the government will probably give CIC more money to manage, but that the size of the capital injection was unclear.