“Dollar declines to new low”. This statement could be applied against any number of currencies as the US dollar or Greenback keeps trending lower. The dollar declined to $1.6038 per euro, the lowest since the Euro’s inception in 1999. It fell to 104.97 yen, from 106.14 yen yesterday. The U.S. dollar also declined to a 25-year low against the resource driven and higher yielding Australian and Canadian dollars. The Dollar Index, which tracks the greenback against the currencies of six U.S. trading partners, fell to a multi-month low. In my previous US dollar update there were signs that the dollar was recovering, but alas it was a false dawn. Here are the main reasons why the US dollar is and will continue to decline in the near term:
1. Interest rates are going up in other developed countries to control inflationary pressures, especially in the EU and Australia. This rate differential makes investing in those regions/countries more attractive and hence reduces the demand and relative value of the US dollar. A month ago, it looked like the Fed was going to raise US interest rates here to control inflation but with recent banking and credit crunch woes, this looks less likely now which only exacerbates the yield differential causing the dollar to tumble lower.
2. Confidence in the US financial system is very low as may international investors think the US is heading into a deep recession marked by declining asset values. Recent need for government backing of GSE mortgage institutions Freddie Mac/Fannie Mae and the collapse of local banks, with more imminent, is not helping investors confidence. This is prompting foreign entities and governments to pull their money out of the US and thereby placing further selling pressures on the greenback.
3. Speculation. Currency market trading dwarfs any other market in the world and is truly a global market place. This allows a lot of speculation across the globe and currently most are shorting the US dollar in the expectation it will go lower.
Here’s what various analyst and media reports are saying about the outlook for the dollar in 2008 and predictions for 2009 and beyond.
” The euphoria about the Fannie and Freddie bailout is fading,” said Steven Butler, director of FX trading, at Scotia Capital in Toronto. “There are still a lot of problems in the mortgage market. The fact that stocks are having difficulty holding their gains is disappointing and hurting the dollar.” Lending to Fannie Mae and Freddie Mac by the Federal Reserve will increase supply of the U.S. currency, adding to pressure on the dollar to weaken, Ashley Davies, a strategist in Singapore at UBS, the world’s second-biggest currency trader, wrote in a note. Investment by the Treasury would worsen the budget deficit and damage confidence in the government, according to Barclays, the third-biggest currency trader. (Reuters.com)
“Initially the markets took the news of the helping plan for the mortgage lenders as a positive one as the United States tried to ensure confidence in the market,” Daragh Maher, senior currency strategist at Calyon in London, told Forbes.com. “But there has been a reassessment and these initiates are seen now as an increasing worry of the weak financial system, which reflects a weakness across the board [and hence the US dollar]” Maher said. The U.S. government will do whatever it takes to “avoid a systemic meltdown” because so many central banks hold the nation’s agency debt, New-York based analysts Marc Chandler, Meg Browne and Win Thin of Brown Brothers Harriman & Co. wrote in a research note. The report predicted the dollar will stay in a range of $1.53 to $1.60, though it didn’t rule out a weaker rate. “Fannie Mae and Freddie Mac finance the current account deficit by selling agency bonds,” Umemoto said. “They were always very, very stable in the past, with particularly central banks buying their debt. But if international investors start selling, that would be the beginning of a dollar collapse.” (Bloomberg.com)
ABN Amro currency strategist Greg Gibbs said the US dollar continued to soften amid fears about the health of the US financial sector. Mr Gibbs said the failure of mortgage lender, IndyMac, with the US government taking over the bank on Friday, had raised concerns about the outlook for other regional banks. “Banking shares in the US were pummeled overnight, particularly regional banks,” Mr Gibbs said. “There is a high level of focus on the US banking system. What would that mean for policy in the US has been undermining the US dollar.” (The Australian)
The euro could “easily overshoot to $1.61 to $1.62 in the near term if the risk aversion persists,” UBS strategist Geoffrey Yu said in London after the dollar broke $1.60. “It’s very much a dollar story and not a euro story for now.” Fed futures showed investors have trimmed expectations of an increase in the 2 percent benchmark rate in September to 38.5 percent from 49.1 percent a week ago and 87 percent a month ago. The euro’s strength against the dollar won’t last as investors will resume focus on the slowing European economic growth, Yu of UBS said. UBS maintained its forecast for the euro to fall to 1.5300 against the dollar by end of the third quarter and to 1.4000 by the end of 2008. (Bloomberg.com)
“The markets are reacting negatively to the renewed credit crisis in the U.S. and that’s hurting the dollar across the board,” said Roberto Mialich, a Milan-based currency strategist at Unicredit Markets & Investment Banking, a unit of Italy’s largest lender. “The market is speculating that Bernanke will offer a gloomy outlook for the U.S. economy.”
“The reality is the U.S. housing market and credit squeeze haven’t hit bottom yet,” said Takuma Kurosawa, global markets treasurer in Tokyo at HSBC Bank, a unit of Europe’s biggest lender. “That’s discouraging investors from holding dollar assets.” (Bloomberg.com)
Remarks by European Central Bank President Jean-Claude Trichet highlighting inflation worries supported the euro, analysts said. Higher benchmark rates in Europe will boost the return of euro-denominated assets and weigh on the greenback. “The ‘trifecta’ of an ECB rate hike, hawkish comments by Trichet and a negative non-farm payrolls report should provide sufficient ammunition for speculators to mount an attack on the 1.6000 level in the euro-dollar.” (CNBC.com)
“Confidence in the U.S. currency is at very low ebb right now,” said Russell Jones, head of fixed income and currency strategy at RBC Capital Markets. (Marketwatch.com)
Unfortunately, the lower US dollar will also drive inflation domestically and act as a support for higher oil prices. Neither of which is good for the economy. With the US dollar not showing much strength into the future it is important for your investment portfolio to be internationally diversified and to invest in American companies that derive significant overseas earnings. See an updated article on the US dollar trend reversal and sharp uptick: US Dollar Rising and Outlook