THE AMERICAS US Economic Recovery May Not Boost Dollar
“The US trade deficit looks set to deteriorate further in 2003, and possibly beyond,” says Michael
Rosenberg, head of global foreign exchange research at Deutsche Bank in New York.A stronger US economy will create more import demand, he notes.
With the real trade-weighted dollar still trad-ing close to its cyclical highs and providing no lift to exports, it is hard to see where any meaningful improvement in the trade deficit is going to come from, Rosenberg says.
“The trade balance has deteriorated at an alarm-ing pace,” he says.“With the United States on an unsustainable path to ever-larger deficits, one has to wonder just how long the dollar is going to remain firm. It is looking more and more likely that the marketplace is setting itself up for a nasty fall in the dollar sometime in the coming year,” Rosen-berg says.
The dramatic decline in US interest rates in the past two years relative to yield levels elsewhere means that the United States may find itself in a position where it can no longer attract the neces-sary inflow of capital to finance its current account deficit, Rosenberg adds. Given the large trade gap, if the US economy rebounds in 2003 and imports rise by 10%, exports would need to rise by 14.5% just to keep the trade deficit from widening further, he says.
Larry Kantor, head of global foreign exchange research at JPMorgan Chase in New York, says capital flows will be criti-cal to the dollar’s for-tunes this year. He says that while the bank is revising its forecast slightly to reflect a flat to somewhat weaker euro early in 2003, the dollar is likely to resume declin-ing against the euro later this year.
“We believe that along-side the better trend to US growth, European investors will put rela-tively more money to work in US assets, in turn keeping the dollar sup-ported in the first quarter of 2003,” Kantor says. “However, as a healthier US economy becomes discounted and European growth picks up later in the year, we expect the capital flows from Europe to the United States to moderate some-what,” he says.
With the US current account deficit widening further, these dynamics should allow for the euro to rise against the dollar, Kantor says.
EUROPE Weakness in Germany Keeps ECB on Alert
While analysts praised the decision of the European Central Bank to cut inter-est rates by 50 basis points last month, they caution that weakness in the German economy could keep pressure on the ECB to reduce interest rates further.
“Although the [Decem-ber] rate cut took place a little later than desired, the decision should be lauded due to its magni-tude, considering that inflation continues to bor-der just above the central bank’s price stability man-date of 2%,” says Ashraf Laidi, chief currency ana-lyst at MG Financial Group in New York.The ECB chose to pursue a medium-term assessment of price risks, while rec-ognizing the immediate risks to economic growth, he says.
“The central bank has finally shaken off the criti-cism throughout last year that it was ignoring slowing growth,” Laidi says.“It has kicked the ball back into Brussels’ court, where the Euro-pean Union can resume its efforts on rethinking the rigid fiscal constraints currently imposed by the growth and stability pact,” he says.
Laidi says the long-term outlook for the euro looks more positive now that lower interest rates can better absorb poten-tial supply shocks occur-ring from excessive strengthening in the cur-rency.The ECB should be ready for another dose of stimulus in case infla-tion does fall below 2% in 2003, as the central bank currently predicts, Laidi says.
Anne Mills, director of foreign exchange research at Brown Brothers Harri-man in New York, says the ECB rate cut brought a sigh of relief for euro bulls.The half-point cut was more expected than any other outcome but was by no means regarded as a sure thing, she notes.“With this rate move out of the way, the question of the next rate move will emerge quickly,” she says.
Data for the eurozone overall are less depress-ing than the German numbers, although the Teutonic gloom contin-ues to weigh on the over-all assessment, according to Mills.
The continued, albeit modest, expansion in the eurozone’s service sector, which accounts for more than half of gross domes-tic product, is a small ray of hope, she says.
Noting that the Euro-pean Commission has forecast a possible drop in eurozone GDP in the first quarter of 2003 from the fourth quarter of last year, she says this would look perilously close to a reces-sion. If GDP does decline in the current quarter, she adds, it will be only the second quarter-to-quarter drop since 1993.
Mills says Germany is now losing jobs almost as fast as the United States was in the depths of the 2000-2001 recession, and Germany isn’t even in recession—yet.
ASIA Japanese Officials Favor Yen Decline
The pressures against the Japanese yen are mount-ing amid signs that the country’s modest eco-nomic recovery is stalling, analysts say.A weaker yen could provide crucial sup-port to the country’s exporters, they note.
Meanwhile, the volatile fiscal year-end in March is fast approaching.While major banks’ half-year earnings were generally positive, the full-year results are expected to weaken due to tighter bad-loan assessments, says Grace Chen, currency analyst at Deutsche Bank in Tokyo.
Separately, the recent talk of foreign bond pur-chases by Japanese investors and potential inflation targeting are also discouraging investors from holding positions in the yen, as Bank of Japan governor Masaru Hayami is due to retire by mid-March, Chen says.
Economic data over recent weeks have sug-gested that Japan’s recov-ery is slowing, and sup-port to exports is worth courting, she says. Com-ments by Ministry of Finance officials have made it clear that the government favors a weaker currency.
Marc Chandler, chief currency strategist at HSBC Bank USA in New York, says there are lim-its to the Japanese strat-egy of talking the yen down, however.“Of all the factors that move the foreign exchange market, policy wishes of officials are not among the most important variables,” he says.
What’s more, Japanese exports account for only 10% of the country’s gross domestic product, he notes.And Japan’s trade partners will respond to any efforts to weaken the yen, he adds.
According to Chandler, to the extent that a weak-ening of the yen helps to temper deflation, it is a negative factor for Japan-ese government bonds, and Japanese banks hold more government bonds than equities, he notes.
As the March 31 fiscal year-end nears, there is the possibility of heavy yen repatriation, says Anne Mills of Brown Brothers Harriman in New York. Despite the clear wishes of Japanese government officials for a weaker cur-rency, this sort of consen-sus expectation often proves wrong, she says. Widespread repatriation of Japanese assets abroad, as financial institutions act to improve balance sheets, raises the possibil-ity that the yen could begin to strengthen, once again proving the consen-sus wrong.
Gordon Platt
