Dollar’s Rally Seen Ending

Weakness in U.S. economy suggests further Fed bond purchases.

The most accurate foreign-exchange forecasters say the dollar’s best quarterly rally since 2008 has no chance of continuing to year-end as a slow economy spurs the Federal Reserve to flood the world with more U.S. currency.

Led by JPMorgan Chase & Co., the five best strategists as measured by Bloomberg News in the six quarters through September see the currency averaging $1.34 per euro in the final three months of 2011, from $1.3387 on Sept. 30. They estimate it will average 76.6 yen, from 77.06.

Reports on everything from jobs to housing and incomes show the world’s largest economy may be in jeopardy of slipping back into recession, forcing the Fed to print more money for the third time in three years to inject into the financial system through bond purchases. Forecasters say the strategy would debase the dollar, which is down 22 percent since March 2009 even with last quarter’s gains.

“The Fed could start discussing the expansion of its balance sheet by the end of this year and begin with the asset purchases in early 2012,” John Normand, the London-based global head of foreign-exchange strategy at JPMorgan, said in an interview on Oct. 5. “The bias will be for a modest retracement in the dollar from current levels. Investors are already extraordinarily long of dollars.”


 
Global Turmoil
Normand, the top forecaster with a 4.37 percent margin of error, sees the 17-nation euro at $1.38 by year-end. The firm’s yen prediction is 75 per dollar.

The U.S. currency rose 0.3 percent to $1.3605 per euro and was little changed at 76.65 yen at 11:22 a.m. London time.

Turmoil in global financial markets last quarter as Europe’s sovereign-debt crisis deepened and Standard & Poor’s stripped the U.S. of its top AAA credit rating led investors to shun all but the safest assets, such as Treasuries. That helped spark a 7.14 percent gain in the dollar against a basket of nine developed-nation peers as measured by Bloomberg Correlation-Weighted indexes. That beat bonds, stocks and commodities.

While almost three years of near-zero interest rates from the Fed and $2.35 trillion of bond purchases helped pull the economy out of a recession, concern is rising that gross domestic product may soon start to shrink.


 
Jobs, Incomes
The U.S. unemployment rate has held at or above 9 percent every month except for two since May 2009, including a reading of 9.1 percent in September. Personal incomes fell for the first time in almost two years in August, declining 0.1 percent, the Commerce Department said Sept. 30. New home purchases declined to a six-month low in August.

The Organization for Economic Cooperation and Development cut its forecasts for the U.S. last month, saying the $15 trillion economy likely grew 1.1 percent in the third quarter and will expand just 0.4 percent in the fourth.

The Fed “will continue to closely monitor economic developments and is prepared to take further action as appropriate to promote a stronger economic recovery in a context of price stability,” Chairman Ben S. Bernanke said Oct. 4 in testimony to Congress’s Joint Economic Committee in Washington.

To the most accurate forecasters, that may mean the Fed conducts a third round of quantitative easing, or QE. After cutting rates to a record low, the Fed twice bought bonds to inject cash into the economy.


 
Dollar Reaction
Bloomberg Correlation-Weighted Indexes show the dollar tumbled 13.6 percent after the Fed bought $1.75 trillion in Treasuries and mortgage debt from December 2008 through March 2010. It sank 6.3 percent between November 2010 and June 2011 as the Fed spent $600 billion buying bonds.

“Further QE will ultimately put a floor under euro- dollar,” Jonathan Cavenagh, a Singapore-based senior currency strategist at Westpac Banking Corp., the second most-accurate forecaster, said in a telephone interview Oct. 4.

While the U.S. currency may advance beyond $1.30 per euro during bouts of risk aversion, it will struggle to rally above that level and end the year at about $1.31, Cavenagh said. Westpac had a margin of error of 4.44 percent in the survey.

For all the headwinds facing the U.S. economy, it will likely hold up better than those of Europe and Japan. Growth in the three biggest euro economies will shrink 0.4 percent this quarter and will stall in Japan, the OECD said Sept. 8.


 
‘Haven Bid’
“In the short term, the dollar will continue to strengthen on the safe-haven bid and over the medium term it will benefit from the fact that the U.S. economy is still in better shape than most other major economies,” said Daragh Maher, London-based deputy head of global foreign-exchange strategy at Credit Agricole SA. “The recession fears in the U.S. are overblown. I don’t think we’ll get QE III.”

The company, ranked fifth in the survey with a margin of error of 4.83 percent, expects the dollar to finish this year at $1.33 per euro, and appreciate to $1.26 by the end of 2012. Credit Agricole forecasts the U.S. economy will grow 1.8 percent this year, compared with 1.2 percent in the U.K. and 1.1 percent in the euro-region, Maher said.

Hedge funds and other large speculators expect America’s currency to strengthen against a basket of the euro, yen, pound, Swiss franc, Mexican peso, and the Australian, Canadian and New Zealand dollars.


 
Net Wagers
The difference in the number of contracts betting on an advance in the dollar compared with those on a decline rose to 131,704 last week, according to Commodity Futures Trading Commission data released Oct. 7 and compiled by Bloomberg. That’s the most since June 2010. In March, there were a net 405,267 contracts outstanding betting on a decline, a record.

At its last policy meeting on Sept. 21, the Fed decided against another round of QE and instead said it would sell $400 billion of short-term debt holdings and invest the proceeds in longer-term Treasuries to reduce borrowing costs and counter rising risks of a recession.

After stripping out distortions caused by the Fed’s record low overnight lending rate, two-year Treasury notes yield just 0.2 percentage point less than five-year securities, suggesting the economy has a 60 percent chance of contracting within 12 months, according to Bank of America Corp.

Analysts are wary of further gains in the dollar and expect it to stay little changed against Group of 10 currencies this quarter, according to data compiled by Bloomberg. They forecast it will end next year at $1.40 per euro, based on the median estimate of 31 analysts surveyed by Bloomberg.


 
Fiscal ‘Challenges’
Last quarter’s survey of the top-ranked strategists showed that while they correctly forecast that a year-long slide in the dollar would end, they failed to predict its rally. The best estimates showed the greenback would end 2011 at $1.42 per euro, on average, from $1.43 on July 8, the last trading day before the poll’s publication.

“We were never particularly optimistic on the euro and always more optimistic on the dollar,” Vassili Serebriakov, a currency strategist at Wells Fargo & Co. in New York, said by telephone Oct. 3. Fiscal “challenges appear more manageable for the U.S. than Europe,” where consensus among 17 nations is harder to reach, he said

Wells Fargo, ranked third in Bloomberg’s survey with a 4.58 percent margin of error, estimates the dollar will end the year at $1.32 per euro.


 
Deficits, Diversification
For Oversea-Chinese Banking Corp., the U.S.’s budget deficit of more than $1 trillion, the possibility of another round of QE by the Fed, an improvement in the euro-area debt crisis and foreign-exchange diversification by central banks may start to weigh on America’s currency.

“Going out into 2012, I think the weak dollar story may start to reassert itself,” Emmanuel Ng, a currency strategist at the fourth-ranked forecaster, said in a phone interview on Oct. 6. The firm sees the dollar ending this year at $1.32 euro, before falling to $1.35 by end of the first quarter and ending 2012 at about $1.43.

Strategists were ranked according to the accuracy of their estimates for 13 currency pairs in each of six quarters beginning with the three months ended June 2010. To test long- term accuracy, Bloomberg News added one annual forecast, which was made on Sept. 30, 2010, for Sept. 30, 2011.

Only firms with at least four forecasts for a particular currency pair were ranked, and only those that qualified in at least eight of 13 pairs were included in the ranking of best overall predictors. Thirty-six firms qualified.



Bloomberg News

 

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