Corporate Finance : Foreign Exchange
Analysts Expect Dollar Déjà vu: More Losses


The outlook for the dollar in 2005 depends on a host of factors, some of which nobody could possibly foresee. But the most likely scenario, analysts say, is a continued orderly decline, with periods of relative stability.

“Now that Treasury secretary John Snow has been kept at his post, we could expect the status quo in the US currency to prevail,” says Ashraf Laidi, chief currency analyst at MG Financial Group in New York.

Treasury secretaries with a manufacturing background tend to pursue policies that are most friendly to US exports and hence favor a weaker dollar, he says. Those Treasury chiefs from a predominantly academic or Wall Street background recognize the importance of a strong dollar to attracting foreign capital to US securities, Laidi says.

Snow has extensive experience in corporate America, including 25 years with CSX, one of the nation’s largest freight companies, and head of the Business Roundtable.

“Naturally, the factors behind the dollar’s moves are diverse, ranging from swelling unemployment in manufacturing and resounding protests against the strong dollar by the US manufacturing lobby, to the increasingly exposed US role in the shaky geopolitical landscape,” Laidi says.

The US corporate scandals and accounting malfeasance as well as the imposition of trade tariffs in the spring of 2002 have also contributed to dollar damage, Laidi notes.

The advantages of a weak dollar are two-fold, Laidi says. Foreign-generated revenues are enhanced when they are translated into dollars, and US exports get a boost from increased competitiveness in terms of price.

Meanwhile, the Bank of Japan will find it futile to intervene by selling yen for dollars when the problem is that of dollar weakness instead of yen strength, Laidi says.

Japan’s structural current-account surplus has maintained support for the yen and is expected to continue doing so as long as net investment into

Japan does not turn overwhelmingly negative, says Michael Woolfolk, senior currency strategist at Bank of New York.

The yen continued to strengthen in 2004 due to a net inflow of trade and investment despite heavy intervention early in the year by the Bank of Japan on behalf of the Ministry of Finance, he says.

“The combination of a record Japanese current-account surplus, heavy foreign investment into apanese equities and a broad-based dollar decline is expected to maintain pressure on the yen to appreciate despite recent softness in the Japanese economy,” Woolfolk says.

David Gilmore, economist and partner at Essex, Connecticut-based Foreign Exchange Analytics, says that no matter how much complaining is heard from Europe and Asia over the weak dollar, the markets are doing what they are supposed to do in the face of a record US current-account deficit and the emergence of the euro as a second reserve currency.

“The market is adjusting, and doing so in an orderly fashion,” he says. “No wonder the US Treasury is not hitting the panic button on the dollar or jumping into action behind the coercion of disgruntled European monetary authorities.”

Gilmore says the US Treasury has a pretty good idea of what is happening with investor demand for US government securities and is quite confident that the world has not lost confidence in US assets and the dollar.

“Where things could get dicey for central bankers, and eventually even the US Treasury, is if China delays a devaluation and drags out the entire process of moving to full convertibility, and the dollar continues its descent mainly versus the euro,” Gilmore says.

This could turn into a vicious circle, with European investors liquidating US assets, and the dollar’s losses continuing, Gilmore says. In such a case, not even the faster growth of the US economy relative to that of the eurozone, would be enough to keep the dollar’s decline orderly, he says.

“Never say never, but I am sticking with the orderly theme for the dollar and yield curve,” Gilmore says. The US authorities don’t have to worry about a collapse of the bond market, so long as they don’t completely ignore the need for a sound US fiscal policy, he says.

The Treasury’s auction of $15 billion of five-year notes in December drew a record-high 65% participation by indirect bidders, which are usually a proxy for foreign central banks.

This was not only higher than the 44% seen in the previous auction of five-year US Treasury notes but was the highest since data on foreign participation began to be made public in the summer of 2003.

Analysts say it is reassuring that foreign official buying of US treasury securities is continuing in the face of the dollar’s losses. However, the data also indicate how much the US is relying on foreign governments, as opposed to private investors, to finance the current-account deficit. This does little to allay concern that foreign demand for US assets will diminish.


Gordon Platt
 

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