Could the long dollar slide be over?
For the better part of the past decade, and particularly in the last few months, the American dollar has been the 98-pound weakling of the foreign exchange world. It has lost value against almost every other global currency — not just the euro, pound and yen but even the Romanian new leu and the Latvian lats.
Driven largely by the Federal Reserve’s policy of printing dollars to help spur a healthy economic recovery that remains stubbornly elusive, the dollar, weighed against a basket of other currencies, hit a 40-year low this month.
But betting against the dollar may no longer be such a safe play — not necessarily because of any sudden macroeconomic shifts but because of a sense that the long dollar sell-off may have finally gone too far.
Since May 4, the dollar is up 4 percent against the euroand 2 percent against the pound, while rallying against the Romanian and Latvian currencies as well.
The dollar’s bounce, though too brief to be called a trend, has not been driven by any noticeable improvement in America’s economic fundamentals. Indeed, the faint but real risk that Congress will fail to reach agreement on raising the legal ceiling on government borrowing only underscores the still parlous state of the American economy.
At the same time, unemployment in the United States remains stubbornly high, at 9 percent. And there is a strong belief among big money investors that the Obama administration as well as the Federal Reserve chairman, Ben S. Bernanke, tacitly welcome a cheaper dollar to spur exports and encourage American manufacturers to hire more aggressively.
“The U.S. economy is still facing headwinds — from weak housing to reductions in government spending,” said Ray Attrill, a currency strategist for BNP Paribas in New York. “For those reasons, we think the export sector is where policy makers are looking for growth.”
But analysts also see another, more technical reason behind the dollar’s long decline — one that may well be ending. Ever since the global financial crisis began to ease in 2009, the appeal of investing in higher-yielding currencies and commodities all over the world has created what, in trader parlance, is called a risk-on, risk-off dynamic.
Investors tend to sell their safer holdings, like United States Treasury bonds, when they feel more bullish. Because 90 percent of the world’s hedge funds are dollar-based, those changes in sentiment can have a depressing effect on the American currency. Reserve-rich central banks in emerging markets have also been selling dollars and buying euros to rebalance their reserve portfolios, said Mr. Attrill, citing recent data from the International Monetary Fund.
“Everything has been strengthening against the dollar — this is something that has not happened in the past,” said Stephen L. Jen, an independent currency strategist and former economist for the International Monetary Fund.
But that momentum now appears to have swung too far to one side — particularly as Europe’s own debt problems return to the limelight. Mr. Jen sees the euro’s rise to a high of $1.49 from $1.19 over the last year as overdone, especially in light of the festering problems in Greece and other weak euro zone economies. Even now, the euro is back down to $1.42.
“With its sovereign debt issue and the growth differential in the euro zone,” Mr. Jen said, the euro is “just too expensive.”
Other analysts also have begun to say enough already.
In part, that is because much of the dollar’s recent weakness was driven by the perception that the European Central Bank, and to a lesser extent the Bank of England, were more likely to raise interest rates to keep inflation under control than was the Federal Reserve, which remains committed to keeping short-term interest rates near zero. With rates likely to be higher in Europe than in the United States, traders moved their money out of United States government bills and bonds to gain greater returns abroad.
But the stronger the euro got, the more likely it became that its rise would begin to bite back. As the euro rose to nearly $1.50, the strength of the currency started to raise doubts about whether the mighty German export machine, which gained competitive strength when the euro was weaker, could continue to perform so successfully around the world.
Meanwhile, with growth negligible or nonexistent in Greece, Ireland, Portugal and Spain, and with each of them facing huge challenges paying their debts, Europe’s position looks more precarious — especially if the European Central Bank remains determined to push interest rates higher this year.
“The beleaguered European periphery is now choking on a caustic concoction of a surging euro exchange rate, a deflating E.C.B. balance sheet and rising short-term funding rates,” Michael T. Darda, chief economist of MKM Partners, wrote in a recent note to clients.
“If there is no path to a reasonable recovery in nominal G.D.P. for the European periphery, fiscal austerity will fail and serial defaults and/or restructurings likely will follow,” he wrote.
Just as puzzling to some has been the robust performance of the British pound over the past year — up 11 percent against the dollar.
On the surface, the raw economic numbers in Britain are as bad as anywhere in Europe: a deficit of 10 percent of gross domestic product, a weak banking sector and sluggish economic growth that continues to be revised downward.
As Paul De Grauwe, a Brussels-based economist noted recently, Britain’s 10-year bond yields are 2 percent below those of Spain, despite Spain’s having lower debt and deficit figures.
But Britain has the benefit of running its own monetary policy. And its status apart from the United States dollar and outside the euro zone has attracted foreign bond investors seeking a haven.
To British officials, such a trend reflects its ambitious program to cut government spending and bring down the deficit. But a recent report on the British economy by Morgan Stanley strikes a more skeptical tone, highlighting six problem areas that could cause investors to take flight.
Morgan Stanley cites the effect on growth that public sector cuts will have, the continued vulnerability of the country’s banks to a weakening real estate market and increased tensions between the Conservatives and the Liberal Democrats in the coalition government.
The upshot is that “the pound could be in for a pounding,” the analysts conclude.
Predicting a currency’s direction is about as inexact as sciences come, especially in today’s volatile markets. But one thing seems certain: the dollar may no longer be king, but after a long slump it can still flex its muscles from time to time.
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