May 16, 2011How low can the dollar go?
The U.S. dollar has seen its fair share of ebbs and flows and has lived to tell the tale. But the past ten years has seen more ebbs than flows, giving many observers reason to question the long-term sustainability of the U.S. dollar and whether it is time to look for alternatives.
Clearly, the dollar has been hit by one of the worst financial crisis the world has seen. The U.S. economy has been in a shambles and prospects look fair to middling at best for the world's largest economy in the near future.
But the slide in the U.S. dollar this year has surprised many. "While we had been looking for the dollar to weaken in 2011, the fall has been more rapid and larger than we had expected. Since the beginning of the year, the dollar is down about 5% on a trade weighted basis, and by 8% against the EUR," said HSBC in a note to clients.
It's not that the euro, the American dollar's closest alternative, has been a paragon of stability. Crisis in Ireland, Greece and Portugal has meant that the euro has been lurching from one crisis to another - and many argue it is verging on a sovereign default. But so poor has the U.S. outlook been, that even the eurozone looks more attractive.
There is good reason for the U.S. dollar to be where it is. Standard & Poor's (S&P) decision to cut the outlook on the US's long-term rating from stable to negative for the first time since the attack on Pearl Harbour 70 years ago, speaks spoke volumes of how much the U.S. economy has fallen from its exalted status.
S&P noted that compared with the small number of developed countries with a coveted AAA rating, the US had "very large budget deficits" which reached as high as 11% in 2009. With the political infighting between the Republicans and Democrats on the deficit now so bitter that there was a risk of the US government being shut down earlier this month, S&P said it had taken the decision to change its outlook because "the path to addressing these issues is not clear to us".
"We believe there is a material risk that US policymakers might not reach an agreement on how to address medium- and long-term budgetary challenges by 2013; if an agreement is not reached and meaningful implementation is not begun by then, this would in our view render the US fiscal profile meaningfully weaker than that of peer 'AAA' sovereigns," said S&P.
Total government outstanding debt in the United States stood at $13.6-trillion at the end of 2010 and is now rapidly approaching the $14.3-trillion ceiling currently mandated by Congress.
"Default by the US government would be so damaging that it seems inconceivable that Congress would allow it to happen, but it does draw attention to the serious debt issue that the US (like Europe) will have to address," notes HSBC. "This has again focussed attention on the dollar's role as the principal reserve currency and raised the prospect of increased reserve diversification."
Market participants would take the dollar, Treasuries, and the S&P 500 out behind the barn and shoot them," says Steve East, chief economist for Height Analytics. "The ultimate damage could be far greater," agrees Terry Bolton of J.P. Morgan.
The second major concern regarding the U.S. has been the economic figures coming out of the world's largest economy, which have failed to impress and fallen below market expectations.
HSBC notes that on a purchasing power parity method the U.S. dollar is undervalued by 25% against a weighed basket of other currencies.
It's not that the euro, the American dollar's closest alternative, has been a paragon of stability. Crisis in Ireland, Greece and Portugal has meant that the euro has been lurching from one crisis to another - and many argue it is verging on a sovereign default. But so poor has the U.S. outlook been, that even the eurozone looks more attractive.
There is good reason for the U.S. dollar to be where it is. Standard & Poor's (S&P) decision to cut the outlook on the US's long-term rating from stable to negative for the first time since the attack on Pearl Harbour 70 years ago, speaks spoke volumes of how much the U.S. economy has fallen from its exalted status.
S&P noted that compared with the small number of developed countries with a coveted AAA rating, the US had "very large budget deficits" which reached as high as 11% in 2009. With the political infighting between the Republicans and Democrats on the deficit now so bitter that there was a risk of the US government being shut down earlier this month, S&P said it had taken the decision to change its outlook because "the path to addressing these issues is not clear to us".
"We believe there is a material risk that US policymakers might not reach an agreement on how to address medium- and long-term budgetary challenges by 2013; if an agreement is not reached and meaningful implementation is not begun by then, this would in our view render the US fiscal profile meaningfully weaker than that of peer 'AAA' sovereigns," said S&P.
Total government outstanding debt in the United States stood at $13.6-trillion at the end of 2010 and is now rapidly approaching the $14.3-trillion ceiling currently mandated by Congress.
"Default by the US government would be so damaging that it seems inconceivable that Congress would allow it to happen, but it does draw attention to the serious debt issue that the US (like Europe) will have to address," notes HSBC. "This has again focussed attention on the dollar's role as the principal reserve currency and raised the prospect of increased reserve diversification."
Market participants would take the dollar, Treasuries, and the S&P 500 out behind the barn and shoot them," says Steve East, chief economist for Height Analytics. "The ultimate damage could be far greater," agrees Terry Bolton of J.P. Morgan.
The second major concern regarding the U.S. has been the economic figures coming out of the world's largest economy, which have failed to impress and fallen below market expectations.
HSBC notes that on a purchasing power parity method the U.S. dollar is undervalued by 25% against a weighed basket of other currencies.
"There is little doubt that the dollar is "cheap". However, long term fundamental valuations can stay a long way out of line for a protracted period, so there is little reason to expect an imminent recovery on this basis alone."
SHORT-TERM UPTREND
Since Osama Bin Laden's death, the U.S. dollar has rallied, giving hopes of a more sustained recovery. While this 'feel-good' factor has bumped up the U.S. dollar, most analysts see this as a short-term rise.
"The U.S. dollar will soon meet major resistance and overbought conditions," says Jeb Handwerger of Gold Stocks Trade. "Over the past 11 months these dollar rallies have fizzled out very quickly over four weeks. There is no concrete evidence at this juncture to predict a major turning point in commodities or the U.S. dollar."
Goldman Sachs and other Wall Street banks continue to see commodities, especially oil, driving upwards in the near future and there is no fundamental shift that would see the dollar rising from its current floor.
The Gulf countries are seeing signs of inflation due to the low dollar, but there is not a scant hope that they will look to de-peg from the U.S. dollar or revalue.
"The U.S. dollar will soon meet major resistance and overbought conditions," says Jeb Handwerger of Gold Stocks Trade. "Over the past 11 months these dollar rallies have fizzled out very quickly over four weeks. There is no concrete evidence at this juncture to predict a major turning point in commodities or the U.S. dollar."
Goldman Sachs and other Wall Street banks continue to see commodities, especially oil, driving upwards in the near future and there is no fundamental shift that would see the dollar rising from its current floor.
The Gulf countries are seeing signs of inflation due to the low dollar, but there is not a scant hope that they will look to de-peg from the U.S. dollar or revalue.
The lower dollar protects Gulf exports and also ensures that oil prices remain high, which helps GCC states meet their own raised domestic expenditure requirements.
Even though much of the region's foreign assets are in the U.S. dollar, it is almost improbable for the Gulf to move assets into other currencies in any meaningful way as it will have the adverse effect of further devaluing the U.S. dollar and their own dollar-denominated assets. The Chinese, which are the biggest buyers of U.S Treasuries at $3 trillion, face a similar issue.
Even though much of the region's foreign assets are in the U.S. dollar, it is almost improbable for the Gulf to move assets into other currencies in any meaningful way as it will have the adverse effect of further devaluing the U.S. dollar and their own dollar-denominated assets. The Chinese, which are the biggest buyers of U.S Treasuries at $3 trillion, face a similar issue.
According to the Federal Reserve, the U.S. dollar "constitutes more than half of other countries' official foreign exchange reserves."
This stranglehold of the U.S. dollar over the fortunes of other economies will ensure that the greenback will remain the reserve currency of the world, despite calls by many observers to consider the euro, the Japanese yen, Swiss francs, gold or even the Chinese renminbi as alternatives.
So what could make the dollar rally?
This stranglehold of the U.S. dollar over the fortunes of other economies will ensure that the greenback will remain the reserve currency of the world, despite calls by many observers to consider the euro, the Japanese yen, Swiss francs, gold or even the Chinese renminbi as alternatives.
So what could make the dollar rally?
If the dollar is very cheap, and positions in the market are very short of dollars, then a short term recovery could be driven by position liquidation triggered by an event outside the foreign exchange market.
A good candidate for such a trigger would be the very sharp fall in crude oil prices seen last week, which took West Texas Intermediate futures prices from a high of $115 barrel to a low of $95 barrel in four days
"An even more extreme move was seen in silver, which fell nearly 30% in the same period. If the sharp fall in prices is indicative of position liquidation from investment funds, then it is possible that it will trigger a similar liquidation in currency funds," says HSBC. "As well as the dollar, we would see the AUD as a prime candidate for a correction."
Another trigger could be a major shift in U.S. Federal Reserve, which is expected to curb its ultra-loose policy at the end of the second tranche of quantitative easing, or QE2. Resolutions over the debt crisis in Congress and a clearer path on how the U.S. will handle its debt, will improve sentiment towards the U.S. dollar.
Concerns over US fiscal sustainability have combined with low interest rate expectations and constrained market volatility to keep the dollar on a downward trend, says HSBC. "Having recently made new lows on a real effective basis, the dollar is undoubtedly 'cheap', but, other than shorter term recoveries based on position adjustment, it is difficult to see the dollar enjoying a sustained recovery until there are significant changes to market perceptions about US monetary and fiscal policy prospects.
There is of course the scepticism whether the U.S. government wants a strong U.S. dollar. Even though the U.S. Federal Reserve chairman proclaimed recently that the Federal Reserve "believes that a strong and stable dollar is both in American interests and in the interest of the global economy," but few analysts believe that be true.
The reality is that a cheaper dollar helps U.S. imports, especially at a time of anaemic economic growth. There is also the U.S. butting heads with the Chinese over its undervalued renminbi currency.
Combined, these factors point to the U.S. dollar either languishing at its current low level or plumbing new depths, at least in the near future.
read more @ http://www.zawya.com/story.cfm/sidZAWYA20110516050156/How_Low_Can_The_Dollar_Go
"An even more extreme move was seen in silver, which fell nearly 30% in the same period. If the sharp fall in prices is indicative of position liquidation from investment funds, then it is possible that it will trigger a similar liquidation in currency funds," says HSBC. "As well as the dollar, we would see the AUD as a prime candidate for a correction."
Another trigger could be a major shift in U.S. Federal Reserve, which is expected to curb its ultra-loose policy at the end of the second tranche of quantitative easing, or QE2. Resolutions over the debt crisis in Congress and a clearer path on how the U.S. will handle its debt, will improve sentiment towards the U.S. dollar.
Concerns over US fiscal sustainability have combined with low interest rate expectations and constrained market volatility to keep the dollar on a downward trend, says HSBC. "Having recently made new lows on a real effective basis, the dollar is undoubtedly 'cheap', but, other than shorter term recoveries based on position adjustment, it is difficult to see the dollar enjoying a sustained recovery until there are significant changes to market perceptions about US monetary and fiscal policy prospects.
There is of course the scepticism whether the U.S. government wants a strong U.S. dollar. Even though the U.S. Federal Reserve chairman proclaimed recently that the Federal Reserve "believes that a strong and stable dollar is both in American interests and in the interest of the global economy," but few analysts believe that be true.
The reality is that a cheaper dollar helps U.S. imports, especially at a time of anaemic economic growth. There is also the U.S. butting heads with the Chinese over its undervalued renminbi currency.
Combined, these factors point to the U.S. dollar either languishing at its current low level or plumbing new depths, at least in the near future.
read more @ http://www.zawya.com/story.cfm/sidZAWYA20110516050156/How_Low_Can_The_Dollar_Go
