Tags: dollar

Too Early to Write Off Dollar

Friday, 20 Mar 2009 07:20 AM

The Federal Reserve's surprise announcement on Wednesday that it will buy longer-term U.S. government debt fueled a steep sell-off in the dollar, but don't write the greenback off yet.

While the dollar's decline may have further to run in the near term, more deterioration in economies around the world will benefit the greenback, given its safe-haven status, analysts said.

"We do not think this is the beginning of a new trend for the dollar," said Michael Woolfolk, senior currency strategist at The Bank of New York Mellon in New York. "We expect the (global economic) outlook to renew its deterioration later this year, which should prompt a flight back into U.S. dollars."

Further boosting the dollar is a growing view that the Fed's pro-active approach in handling the crisis will help the United States be the first to recover from the downturn, said Ronald Simpson, managing director of global currency analysis at Action Economics in Tampa, Florida.

In the options market, though, investors have started to position themselves for further dollar weakness. Signals emanating from "risk reversals" used in the market to gauge currency sentiment have shifted its bias in favor of euro calls and dollar puts in the wake of the Fed's decision.

The Fed said on Wednesday it will purchase $300 billion of long-dated government debt over the next six months, its first large-scale purchase of bonds since the early 1960s. It will also boost the buying of mortgage-backed securities and agency debt.

The move raised concerns that an expansion of the Fed's balance sheet would lead to oversupply of dollars and stimulate inflation down the road.

STRONG OUTLOOK FOR EURO CALLS

The ICE Futures' dollar index, a gauge of the greenback's performance against a basket of six major currencies, plunged 3 percent, its worst showing in about a quarter of a century, according to Reuters data.

On Thursday, it last traded down 1.4 percent at 83.198. The index has lost 5.1 percent so far this week, on track for its largest weekly loss since September 1985.

The risk-reversal curve, meanwhile, now stands fully in favor of euro calls. The one-year and one-month risk reversals in euro/dollar show calls at 0.25/0.50 and 0.8/1.1, the strongest bias for euro gains since mid-December, according to IFR data.

Traders have further cited talk of one-month $1.40 strikes in euro/dollar, which suggests market participants are betting this euro rally could last for some time. Some were also looking at $1.48 in the currency pair in three months. On Thursday, the euro was last at $1.3660.

CASH FLOOD MEANS LEVEL PLAYING FIELD

The Fed's move came after central banks in Britain, Japan and Switzerland have embraced some form of quantitative easing, the process of flooding the banking system with funds to promote lending when interest rates are already at zero.

Action Economics' Simpson said at some point, "if every G7 central bank is engaged in quantitative easing, that levels the playing field."

"Right now, everybody is looking at 'oh no, the Fed is engaged in quantitative easing and printing money ... ' but so is the United Kingdom, so is Switzerland, so is Japan," he said. "It's only a matter of time before the (European Central Bank) has to start doing something different because they're way behind the curve."

Simpson said in the short term, the euro may climb some more to $1.39 to $1.40, but the dollar is unlikely to weaken further beyond that.

Despite the United States being at the center of the global financial crisis, the dollar has soared in recent months as investors sought shelter in U.S. Treasuries, which are backed by the full faith and credit of the U.S. government.

Analysts said the Fed's surprise action poses little risks to the dollar's role as the world's main reserve currency.

"The dollar remains the sole safe-haven currency in the world. It's the reserve currency of first choice among central banks," Bank of New York Mellon's Woolfolk said.

"The simple fact is no other currency can come close to matching it. And of course, no other country really wants a strong currency right now."

Still, being a reserve currency suggests the dollar will remain susceptible to swings in risk appetite, said Michael Hart, European head of FX strategy at Citigroup in London.

"While the dire economic situation and (quantitative easing) represent a drag on the U.S. dollar, all else being equal, another bout of risk aversion could halt this in its tracks as capital repatriation supports the dollar."

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The Federal Reserve's surprise announcement on Wednesday that it will buy longer-term U.S. government debt fueled a steep sell-off in the dollar, but don't write the greenback off yet.While the dollar's decline may have further to run in the near term, more deterioration in...
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2009-20-20
Friday, 20 Mar 2009 07:20 AM
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