How the dollar got its mojo back
By
Associate Editor
David Stevenson
Aug 29, 2008
What's been driving the greenback?
It seems the buck's got its mojo back, at least against the European currencies.
From an exchange rate of $1.55 against the euro on 7 August, the US dollar has recovered some 5% of its value within just three weeks. Against the pound, it has risen from $2 to $1.83. Lehman Brothers' analysts haven't seen anything quite like it since 1971.
And with things going from bad to worse in the eurozone, and equally badly in Britain, this could still prove to be the just the start of a long-term transatlantic revival for the greenback.
It's hard to exaggerate just how dramatic the dollar's August rally has been. After falling back to just about its all-time low against the euro towards the end of July, hitting $1.5925 on the 21st, the buck has bounced back to $1.47 today, an 8% move within about a month.
Against sterling, the rebound has been similar. Even the trade-weighted average, based on where America does business, has recovered 6% in the same time.
Now even by the recent standards of fast-moving markets, that's quite special. Commodities certainly, share prices quite possibly, even bond yields - conceivably - can shoot up or down. But major currencies like the dollar and the euro, traded in the largest markets on the planet? They're not supposed to behave like that.
The sheer quantity of foreign exchange changing hands, with daily volumes estimated by the Bank of International Settlements to be over $4 trillion in 2007, should mean that these are the most efficiently-priced financial markets of all.
So this move in the dollar, "close to unprecedented" in the 35 years since the currency was decoupled from gold, says the Lehman Brothers currency team, could mean something big.
Of course, as we've pointed out recently, euroland has slowed up very sharply within the last month or two. Spain's in trouble, with its house prices plummeting and its banks dependent on ECB funding to stay afloat. Now even Germany, the rock on which the eurozone has traditionally been based, seems to have thrown in the economic towel. By mid-July, business confidence was evaporating as the German ZEW sentiment indicator suddenly plunged, unexpectedly, to a record low.
At the end of last month, the overall eurozone activity survey plummeted much more sharply than the 'experts' had expected to its lowest point since March 2003. Then this week, the closely-watched German IFO business expectations index fell to its lowest level since the 1991/92 recession. Today the EC Economic Sentiment indicator fell more sharply than expected to a four-and-a-half-year low.
It all points to the European Central Bank, which two months ago was hiking interest rates because it was so scared about inflation, actually reducing them quite soon because it will panic about growth. Lehman is betting on the first cut next January, even though the market isn't expecting a move until July. If the bank's analysts prove right, that would clearly pull the rug from under the euro.
Meanwhile the UK could already be in recession, following last week's news that the economy failed to grow at all in this year's second quarter. Capital Economics now expects an "outright contraction" in 2009, with "a full blown slump a growing possibility".
But if it's all bad news in Europe, there's hardly a great backdrop either for the greenback right now. The US economy is "running on empty", says Capital. Apart from an export surge - and if you can't engineer one of those after your currency has slumped by more than a third in value over the last seven years, what hope is there? – everything else still looks pretty sickly.
Consumer confidence has fallen off a cliff, even if a slight recovery is underway. The property market keeps crumbling, with June house prices 0.5% lower than May and 16% down on last year, according to this week's S&P/Case-Schiller index. And only rabid optimists will derive much consolation from the latest pick up in existing home sales to a 5-month high, as the main reason was the unprecedented surge in sales of foreclosed homes and forced sell-offs.
Then there's another several grillions worth of likely write-downs still to be taken by the banks, etc, etc, …in all not a pretty picture.
So what's been driving the dollar strength, then?
One observer reckons it's all about closet market intervention. "Step from the shadows the Plunge Protection Team (formerly best known as the President's Working Group on Financial Markets)", says Jeremy Batstone at Charles Stanley. "The existence of this group was periodically rumoured to have lain behind occasional bouts of market "manipulation" always on the outer limits of financial market legality. Now the Grouping has official sanction and its role as a market stabiliser enhanced".
In other words, the broker reckons it's all a fix, and that the recent move "smacks of aggressive intervention in the currency markets".
Could be. In January this year, the Telegraph's Ambrose Evans-Pritchard said that the "black arts unit" was created after the 1987 stock market crash and "appears to have powers to support markets with a host of instruments". So maybe it's been up to its tricks again.
But manipulating prices in places as large and liquid as foreign exchange markets isn't easy. And as Daniel Gross has pointed out in the New York Times, "if there is a Plunge Protection Team, it's doing a profoundly awful job". Just look at what happened to Bear Stearns - how effective were the fixers then?
It's also worth noting that Goldman Sachs has just reversed its ten-year bearish stance on the US currency, though forecasting currency moves using fundamental research has always proved notoriously difficult even for the best-informed analysts. That's why most traders look at momentum and believe the trend is their friend. And right now, the dollar clearly has the wind in its sails.
"It's not so much a vote of confidence in the US economy," says Peter Garnham in the FT, as a "realisation that the spill-over from the credit crisis is spreading beyond the US more quickly than previously thought." And as the rest of world's outlook "is getting grimmer by the day," as Marc Chandler at Brown Brothers Harriman puts it, "there's simply nowhere else for investors to go."
Published in Investments
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David Stevenson
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