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Why dollar strength should not be taken for granted

Friday, 16 Aug 2013 | 1:25 AM ET
Beware the greenback and buy the Aussie: Pro
Clifford Bennett, Chief Economist at White Crane Group, talks about why he sees the Aussie dollar as a 'screaming buy' and why he's bearish on the U.S. dollar.

The U.S. dollar saw a broad sell-off on Wall Street on Thursday, and now economists are warning that the greenback bulls may be getting ahead of themselves.

The dollar index, which measures the dollar's value against other major currencies, traded around 81.167 after falling 0.6 percent in U.S. trade Thursday. Meanwhile, the greenback also weakened 0.77 percent against the yen and 0.7 percent against the euro overnight.

Language from Fed members suggesting that the much-anticipated winding down of the Federal Reserve's $85 billion per month bond buying program could get delayed led traders to ditch the greenback, although some of the losses were recouped in Asia trade on Friday.

(Read more: Worst case for Fed taper: mere market 'indigestion')

Clifford Bennett, chief economist at financial services group White Crane Group, told CNBC that even when the Fed does pull back on stimulus, it won't necessarily be good for the dollar, as tapering would imply that the U.S. economy is recovering and encourage American investors to venture overseas.

"We have to remember how much U.S. investors retreated back home during the global financial crisis and the sovereign debt crisis, and really they've left the door open for countries like China to fill the investment gap in Asia and Latin America and elsewhere... the Americans are now coming back into game," he said.

Tomch | E+ | Getty Images

The U.S. government's towering trade deficit, combined with the prospect of lower interest rates for some time, would also weigh on the currency for some time, Bennett added.

"There are some very profound bearish factors at play that have long been there for the U.S. dollar," he added.

While the end of quantitative easing will eventually lead to higher interest rates, which is dollar positive, the Fed has made it clear in recent times that a hike in rates won't happen for some time to come.

(Read more: Relax, interest rates are not too low)

"So we'll (the U.S.) will maintain a trade deficit, maintain lower interest rate levels for some time, and on top of that you're going to have a capital flow that's being withdrawn from the US and a fresh investment wave coming out of the US," he said. "That's a lot of pressure to place on any currency."

Stan Shamu, market strategist at trading firm IG, told CNBC he expected the scale back of Fed stimulus to boost the greenback initially, but warned about the potential for weakness in long term.

(Read more: Don't ignore the trade deficit, it's stifling growth)

"The U.S. dollar can put on a lot of different hats. It really comes down to confidence and the mood of markets at the time," he said.

"It is absolutely correct that if conditions improve to the extent that the emerging markets become more attractive, we will get money coming out of the U.S. and into economies like Brazil and Mexico. And that will probably lead to a slightly weaker dollar," said Shamu.

Shamu said an improvement in the euro zone economy, which this week emerged from an 18 month recession when it posted 0.3 percent GDP growth on Wednesday, could also drive the dollar down if investment there picks up.

"Tapering will support the U.S. dollar initially, (but) later down the track once we've seen some long term stability we'll probably see it come off again," he said.

—By CNBC's Katie Holliday: Follow her on Twitter @hollidaykatie

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