Corporate Finance : Dollar Continues to Sink On Good News and Bad

CF-03-01
The dollar fell to an all-time low against the euro in November, even as the US employment picture improved and the stock market rebounded.

Dealers and analysts say sentiment has turned extremely sour on the greenback amid increasing concern about the US budget and trade deficits and a benign-neglect policy on the dollar by the Bush administration.

With the US elections out of the way, the focus is turning to the long-term structural problems of the dollarand the US bond market, says Anne P. Mills, director of currency research at Brown Brothers Harriman in New York.

The bond market showed the clearest response to President Bushs re-election, with slumping bonds pushing up US yields.This suggests concern about lower foreign capital inflows to the US,Mills says.

Currency traders see no value in holding onto dollars in the face of the continuation of an implicitly weak dollar policy and a deteriorating budget deficit, says Ashraf Laidi, chief currency analyst at MG Financial Group in New York.

Foreign demand for US exports could suffer amid the waning luster of US brands and concern of further US unilateralist foreign policy, Laidi says.

Amid worries about funding the US currentaccount deficit, market participants have little incentive to buy the dollar, says Manfred Wolf, New York-based director of foreign exchange sales at HypoVereinsbank, part of German financial group HVB.

Foreign investors dont even have to sell US assets to create a problem for funding the deficit; they just have to stop buying, Wolf says.

The dollar may continue to suffer from anti- American sentiment around the world, he says, and investors may turn to the euro as the best place to put their money.

The euro has become almost like the Swiss franc, Wolf says.You go into it by default. Its safer to be in the euro than anything else now.

The strong euro is helping to counter the effects of high energy prices and to postpone an interest rate increase in Europe that otherwise would be needed to fight inflation, he says.

Jean-Claude Trichet, president of the European Central Bank, put a Trichet cap on the euros rally of early 2004 with his remarks about brutal moves in the currency.

Trichet made similar comments last month in an effort to control the euros surge against the dollar to fresh records.

At the central banks press conference in early November,Trichet referred to the Group of 7s communiqu opposing excess volatility and disorderly moves in exchange markets.

Ashish Advani, a director in the risk solutions division at Travelex in New York, says the Japanese yen will go under 100 to the dollar, as Asian currencies share the burden of helping the US to adjust its trade imbalance.

The US current account deficit, the broadest measure of foreign trade, has risen to around $600 billion, or about 6% of gross domestic product.A weaker dollar could help to narrow the trade deficit by making US goods more competitive in global markets.

Meanwhile,Advani says, Chinas decision to raise its interest rates for the first time in nine years could be a sign that it will rely more heavily on market-related policies, including exchange-rate policies.

The 27-basis point increase in lending rates early last month was a baby step that wont have much effect, but further Chinese rate increases cannot be ruled out,Advani says.

A yuan revaluation will come, but only on Chinas terms and when China is ready, he says.

When China does move to revalue its currency, it likely will adjust the exchange rate by at least 10% and peg the rate to a basket of five or six currencies, Advani says. Besides the US dollar, this basket likely will include the euro, the yen, the British pound, the Thai baht and possibly the Singapore dollar, he says.

Some Chinese movement on the exchange rate could come soon, says Anne Mills of Brown Brothers Harriman.

Trade tensions will come into focus with the lapsing of the world textile agreement at the end of the year, she says, and preemptive action on the exchange rate could strengthen Chinas position ahead of that event.

The US trade deficit narrowed to $51.6 billion in September from a revised $53.5 billion in August. Despite the improvement, any deficit larger than $50 billion a month is being viewed by the market as fundamentally negative and a reminder that the current account deficit remains in record territory, says Michael Woolfolk, senior currency strategist at Bank of New York. The US trade deficit with China deteriorated to a record $15.5 billion in September and was considerably larger than the $10.4 billion as recently as March.With China responsible for about 30% of the US trade deficit and the trend growing, expect the US and Europe to maintain pressure on China to embrace more flexible exchange rates,Woolfolk says.

cf-03-02


Gordon Platt

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