Dollar 2010: Rate, Not Great, Expectations
You can stop worrying about the weak dollar—you can also stop hoping for a strong one.
Most currency market analysts expect the U.S. currency to build on its 5-percent December bounce, as traders continue to factor in a stonger U.S. economy and an inevitable Fed tighening. Beyond that, however, a lot depends on just how poorly things go for other major currencies, such as the euro, pound and yen.
"The dollar had become oversold," says Michael Woolfolk, senior currency strategist at Bank of New York Mellon. "I see this as year-end positioning with a little added move by speculators."
Woolfolk may be among the least optimistic about the chance of a strong dollar run in 2010, but that's a very relative statement. Most expect modest gains, but no one is expecting a strong, broad-based rally.
"The dollar is very low; it has to move up," says economist Robert Brusca, chief economist with FAO Economics.
In general, analysts expect the dollar to remain weak against the currencies of commodities-driven economies such as Canada, Australia and Brazil, while making gains against those of Japan, Britain and the European Union.
At the same time, after a multi-year bear market that took the dollar to record lows against the euro and parity with the Swiss Franc and Canadian Dollar, analysts say the worst is definitely over.
"There's been a sea change in sentiment," says Boris Schlossberg, of GFT Forex. "The whole thesis began to change when [Novermber] payrolls came out," he explains, referring to the Dec. 4 government report showing that the economy shed just 11,000 jobs, the least in almost two years.
"Fundamental factors will be more favorable for the dollar next year," adds Vassili Serebriakov, a currency strategist at Wells Fargo, which is among the most bullish on the U.S. currency.
Those fundmaentals turn on this oft-cited scenraio: The U.S. recovery will be swifter and stronger than that of most other G7 countries, prompting the Fed to tighten monetary policy first.
At the same time, the U.S. economy is expected to be less vulnerable to future credit market shocks, which will help remind investors of its traditional safe-haven status.
"Rates are going to follow what's happening in the economy," says David Pierce, director at GPS Capital Markets. "We'll see a little more strength short term, due to continuing economic problems overseas and the weakness in the price of gold lately."
Though the Fed is widely expected to raise the federal funds rate no sooner than mid-year, the central bank is likely to undo some of its non-traditional, quantatative easing measures sooner, perhaps as soon as the first quarter.
"One of the big hurdles is the exiting of the Fed from the MBS [mortgage-backed securties] program," says Jacob Oubina, a strategist with Forex.com. He and others suspect that such a move will add at least half a percentage point to mortgage rates.
"The Fed policy flooded the market with cheap-dollar liquidy," adds Serebriakov.
Though there's some concern that problems in the U.S. commercial real estate market could weigh on the U.S. economy, strategists say there's more potential for trouble abroad, which will provide consistent support for the dollar.
"People are beginning to get concnerned about the sovereign credit values in Europe," says Schlossberg. "Portgual, Greece, Ireland, Spain--all of those countries have massive budget deficits."
When debt and budget alarms went off in Greece and Dubai recently, the message was loud and clear to some.
"A flight to quality [the U.S.]? I think there was probably some of that," says Brusca. "These are mini-events that remind people that there is still risk out there."
One final tailwind for the dollar is the apparent end of the gold rally, which during its heydey prompted many an investor to sell dollars to buy gold.
How the Dollar Will Fare vs. the Big Three
Conventional wisdom would argue all of this would make the dollar a screaming buy, yet no one is predicting anything resembling the great bull run of 1995-2001. That's when the dollar pulled out of its last major skid and went on to hit one record highs against other currencies.
Nevertheless, if the forecasts are reasonably correct, the U.S. currency will end 2010 far away from the lows of 2008, when the dollar hit a record low of about 1.60 against the euro and more than two dollars to the British pound.
Here's a snapshot of how the dollar will play out against the big three.
"The most bullish case, " says Scholossberg, is 1.30-1.35. Wells Fargo says 1.32 is possible, but a consensus could be made around the 1.35-level, which is hardly a greap leap from the current 1.42.
"Europe has more problems going on than we do," adds Pierce.
European exporters would certainly welcome a weakening single currency, although the European Central Bank is notoriously paranoid about inflation risks. It resorted to little unconventional easing during the crisis and will always err on the side of tighter monetary policy.
"The U.K. is the weakest link of the G7 economies," says Woolfork, who says a 1.53 level is likely, but a 1.40 level remains possible if both the Fed and ECB raise rates. The most likely range looks to be 1.45-1.50, based on the comments of a half dozen analysts and their forecasts.
Not only has the U.K. economy yet to return to growth, the Bank of England is thought to be considering more quantatative easing, thus making the domestic comditions, more than anything, the key driver of the pound.
There is one, wild card, however.
"Though the U.K. may be the most vulnerable, it is the most levered to the financial markets," notes Schlossberg. "If the rally stalls, it creates a massive amount of pressure on the big firms, but if we see Dow 12,000, then the pound could be back to 1.70-1.75."
Here interest rate differentials holding the key.
"The Bank of Japan will be at zero rates for as far as the eye can see," says Oubina of Forex.com, whose forecast calls for the dollar/yen at 98 mid-year and 105 by the end of 2010.
Virtually every forecast has the dollar/yen rate back around 100 by year's end, a little more 20-percent from current levels.
"Japan has had a great deal of difficulty pulling out of its deflationary problems," says Wooolfork, who also expects no change in official rates during 2010. "That will leave the yen the first choice for the carry trade," usurping the role of the dollar for much of 2009 as investors toyed with the prospect of another commodities boom.
China is also a consideration.
There it is a case of trade policy rather than exchange rates. With the Chinese currency tied to a basket of currencies, it's value against the dollar is essentially fixed, making it immune to shifting global fundmentals.
The evolution of China's economic recovery will play the determining role, analysts say. By mid-year, when its sustainability is clear, some expect the government to follow up on recent hints and return to a policy of incremental, yearly adjustments, to allow appreciation.
Until then, the dollar will make its mark against the currencies of other major trading partners, even if it is tends toweard the unremarkable.
"It may not be that fundamentals are that attractive in the U.S.," says Serebriakov. "There are very few alternatives."
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