Revival in U.S. Dollar Fortunes?
Tuesday, May 8th, 2007Marc Chandler, global head of currency strategy at Brown Brothers Harriman in an April 30, 2007 Barrons article wrote:
“Instead, interest rates, current and anticipated, have caused the dollar’s weakness against the euro and sterling and its larger losses against the antipodean currencies. This also explains the relative underperformance of the yen and the Swiss franc and the perceived attractiveness of many emerging markets.
U.S. economic expansion has encountered headwinds from the dramatic fall in residential construction, which appears to be having a knock-on effect in related sectors, and an accumulation of excess inventories in a few other industries, notably autos.
At the same time, many other countries are still enjoying robust growth. Europe’s central banks — not only the European Central Bank and the Bank of England, but also the Swedish, Norwegian, Danish and Swiss central banks — are tightening. So, too, are those in Australia, New Zealand, India, China and some other countries.
In an investment climate of high liquidity and low volatility, the emphasis on yields hurts the dollar. The Fed has emphasized that it expects the U.S. economy to recover in 2007’s second half and that the risk that price pressures won’t moderate is greater than the risk of the economic slowdown worsening. Yet most primary dealers and market participants still think the next rate move will be down.
The market is underestimating the duration and magnitude of the Fed’s tightening. Remember, the first rate bump-up early last year was supposed to be a “one-and-done” deal before Bernanke succeeded Greenspan. Several times since last June, the market has predicted a near-term cut, only to be disappointed. Never wrong, just early.
The market simply doesn’t believe that a hike is likelier than a cut. …
But what if, in line with the Fed’s baseline forecast, the economy re-accelerates from the dip below 1.5% annualized economic growth? What if the subprime-mortgage problem stays largely contained? What if household demand remains underpinned by income growth that has exceeded inflation, plus the six-year low in unemployment?
The risk that few are taking seriously is that by late in the third quarter or early in the fourth, the market-expectation pendulum could swing toward a rate hike. In the same time frame, the tightening in Europe and elsewhere, excluding Japan, may be ending or at least pausing.
All this points to a revival for the dollar by late in the year. … Adding to upward pressure could be speculators’ need to cover their dollar short positions — now at a record level in the futures market. …
[on stocks] Now is an excellent time for investors to re-evaluate their stock and fund positions, to determine whether investment gains have left them too exposed to currency risk.”
