The recent dollar rally on expectations that the U.S. Federal Reserve will begin to scale back its massive bond buying program later this year, is headed for a sharp reversal, says this economist.
Clifford Bennett, chief economist at Sydney based financial services firm the White Crane Group, said the dollar has been overbought and is due a correction of 15 percent over the next 18 months as the "dollar bubble bursts."
"This week saw the start of a potential major shift lower in the value of the U.S. dollar," he said.
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The prospect of the Fed tapering its $85 billion monthly quantitative easing (QE) program sent the U.S. dollar index, which measures the value of the dollar against the currencies of its major trading partners, to a three-year high early last week. However, the index fell sharply, by around 2 percent, in reaction to the minutes from the Fed's latest policy meeting released on July 10 that ruled out any immediate tapering plans. On Monday the index was at 82.92 in Asian afternoon trade.
"The moment that speculative buying begins to retreat, the U.S. dollar will, and most likely has already, begin a sustained period of decline. The U.S. dollar can be reasonably expected to decline some 15 percent over the next 18 months, if not sooner," he added.
According to Bennett, speculative money has been the key driver of large swings in the dollar's value. Many investors eagerly snapped up the currency in recent weeks on hopes that the end of QE in the U.S. would drive a rally. One of the objectives of such easing is to weaken a country's domestic currency and help aid a recovery, so the withdrawal of such stimulus normally leads to strength.
"While the U.S. dollar bulls are all excited about the end of quantitative easing as a reason to buy the greenback, working away in the background are a few other equally or more powerful bearish factors," said Bennett.
These factors include strong U.S. economic data leading to increased foreign investment by U.S. entities and global stabilization leading foreign holders to sell their Treasurys, both working to dampen dollar strength.
He added that the recent volatility over the Fed Chairman's comments masks a deeper fundamental reality, "it is crucial to understand that the reasons behind a strengthening U.S. economy, involve a weakening U.S. dollar."
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