Dollar will rise against weak euro and pound
Aug 15, 2008
"Sentiment has turned 180 degrees," says Commerzbank's Ulrich Leuchtmann of the recent surge in the US currency. Last week the dollar index, which measures its value against a basket of currencies, put in its best performance in more than three and a half years. On Friday alone the greenback recorded its strongest 24-hour rise against the euro since 1999 and had climbed to a six-month high by the start of this week. Meanwhile, the pound tumbled to a 21-month low, close to $1.90. It seems that "following almost six years of straight decline, the greenback is making a vigorous beginning to what may prove a jittery recovery", commented Ian Campbell on Breakingviews.
What's behind the rise? "Talk and numbers," says Campbell. Part of the dollar's turnaround is down to a change of tone from Federal Reserve chairman Ben Bernanke. Having slashed the federal funds interest rate by a total of 3.25% over seven meetings between September 2007 and April this year, the rate has since been held at 2%. However, his recent comment that US inflation is "too high" – consumer prices jumped 1.1% in June, the second-highest rise since 1982 – raises the prospect of a US rate hike. Then there was encouraging American manufacturing data suggesting the economy may not be in freefall. As Rosemary Righter put it in The Times, "the PMI (Purchasing Managers Index) has held remarkably steady… the sector is adding jobs and export orders are healthy". A falling oil price – down around 20% from its July peak – should also ease input costs.
But these glimmers of hope are counteracted by an unpleasant cocktail of rising unemployment, falling property values and anaemic consumer spending, which is growing at its slowest pace in 17 years. "I don't see a catalyst to a near-term recovery," John Ryding, chief economist at RDQ economics, told Bloomberg. The real reason behind the rise is not that the dollar is strong – it's that the euro and sterling suddenly look even more fragile than the greenback. As Righter notes, analysts have suddenly woken up to "how rapidly business activity and economic sentiment are collapsing across the Atlantic".
The eurozone, until recently a beacon of strength, is now "heading into a recession from which it will struggle to recover" amid a "torrent of appalling data". Last month's eurozone PMI came in at 47.8 – below 50 is considered a contraction – the lowest reading since November 2001. Meanwhile, the confidence indicator fell at a faster rate than anytime since September 2001, dropping from 94.8 to 89.5 between June and July. While several eurozone countries are known to be in trouble, such as Italy and Spain, it is previously rock-solid Germany that has caused most of the latest concerns for the European Central Bank (ECB). Monthly retail sales, in a market that accounts for 28% of the eurozone, were down more than 1%. As Peter Garnham says in the FT, the data "quashes expectations of higher interest rates... the euro's recent joyride is over".
The outlook for sterling, which hit a 26-year high above $2.10 last spring, is also grim. On Monday, a survey of 1,000 business leaders showed that a third expect redundancies at their firms; the CEO of the FSA recently warned the financial services industry to prepare for a downturn similar to the early 1990s recession. So while CPI (consumer price inflation) is well above the 2% target at 4.4%, "the Bank of England will feel happier cutting rates sooner rather than later" to try to protect growth, says Paul Robson at RBS. As BNP Paribas analyst Alan Clarke notes, swap rates already suggest a 50 basis point cut by the middle of 2009. With the recent gloom that has enveloped the dollar now shifting to the euro and sterling, "the dollar is in a genuine recovery", says Stephen Jen of Morgan Stanley. Its rise against both currencies "could run much further".
The big picture: the worst lies ahead
Is the worst of the credit crunch over, as claimed by Barclays' CEO John Varley? Not according to the US Federal Reserve's latest Senior Loan Officer survey. The survey shows that US banks have been steadily tightening lending criteria across all areas of the economy over the past year. What's more, says the Fed, in the third quarter banks intend to tighten lending still further – so that what began as a clampdown on mortgage lending is now affecting all forms of borrowing. "In short, 12 months into the credit crunch, the worst still lies ahead", says Paul Ashworth of Capital Economics.
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