Monday, September 24, 2007

Dollar Should Hold Its Own Against Yen: Miracles DO come true!

Another headline from the WSJ (see article below) that makes it sound as though the dollar is hanging on by a thread. Yes (they say) it is virtually worthless against the Euro but fear not - at least it will "hold it's own" against... the world's most pathetically weak currency, the Yen. What a relief to know the dollar isn't going to zero. Although I'm not sure I believe it because everything I read about the dollar these days seems to have the same conclusion - the end is near. Hogwash. (a technical term used by currency traders). A little perspective please:

First, the long term view:

The dollar has fallen by almost 30% since the peak at the beginning of 2002.

Now, the short term view:
YTD the dollar has depreciated about 6%. Since beginning of July, less than 3% decline.

The Point is that the dollar has taken a sharp hit since the credit crisis (or whatever the nome de jure is for whatever it is that is going on) but seen in context it is just the continuation of a long slow decline. It is nonsense to view the dollar as being in a sort of free fall as many commentators would have us believe. And the idea that a 1/2 point cut in Fed Funds (and probably another 1 percent or more) is going to end the dollar's reign as the world's reserve currency is silly. The dollar is obviously not a robust currency at the moment - but a currency cannot be weak by itself, it has to be weak against something else. And there are simply no candidates with the necessary long term qualifications to take over as primary reserve currency. The Euro may appear to be a juggernaut right now but hang on, is continental Europe really responding so well to the challenges of globalization?

I am not a currency manager (thank God) but my humble opinion is that we may be at the beginning of the end of the dollar decline. Not necessarily at the beginning of dollar strength but just at the end of the long term dollar weakening trend. The dollar is hugely undervalued vs the Euro whilst the US current account deficit (the supposed cause of all this dollar weakness) looks set to fall significantly in the next 12-18 months. Interest rate differentials may drive the dollar over shorter periods but at some point this year a big rebound vs the Euro seems a good bet. The Yen and other Asian currencies are another story. I can't even guess about the Yen because one has to somehow imagine the Japanese economy growing steadily longer term and this is a hard leap of faith to make (what does Fukuda-san have up his sleeve? Not much I bet). Developing Asian currencies should strengthen versus the dollar IF their economies do in fact decouple from US weakness and continue to grow rapidly (which is likely but by no means a 'slam dunk'). Its a mixed bag, very complicated picture - except the end of the dollar is absolutely not going to happen and a bet against the Euro is starting to look very sensible to me.

Dollar Should Hold Its Own Against Yen

September 24, 2007; Page C4

The Federal Reserve's decision to cut interest rates will continue to weigh heavily on the dollar this week, but economic concerns hitting rival currencies will stave off deeper declines for the U.S. currency.

The euro is likely to maintain its gains against the dollar, after hitting a record high of $1.4121 last week. But the greenback may find sanctuary against the yen since the Bank of Japan voted to hold interest rates steady Wednesday, following the Fed's implicit confirmation of U.S. market weakness.

Less-than-optimistic economic data in Japan suggest that interest rates there will likely remain very low into the near future, encouraging investors to borrow the yen to finance the purchase of currencies with higher returns in a strategy dubbed the carry trade.

The euro is expected to trade between $1.41 and $1.42 this week. Against the yen, analysts see the dollar trading in its typical pattern of late, between 113 yen and 115 yen, possibly up past 116 yen.

Late Friday afternoon in New York, the euro was at $1.4090 from $1.4066 late Thursday, while the dollar was at 115.37 yen, from 114.32 yen. The euro was at 162.53 yen, from 160.92 yen. The pound was at $2.0203, from $2.0100. The dollar was quoted at 1.1721 Swiss francs from 1.1723 francs.

Eye on the Bankers

The Fed showed its concern about the U.S. economy's current credit crisis when it cut its target and discount rates by a half percentage point Tuesday. Comments from officials at the European Central Bank and the Bank of England suggest the same concern regarding their economies.

With the euro's break past $1.40 and the momentum the currency has gained, investors and analysts will be looking to possible responses this week by central bankers. The issue is whether the euro will advance again this week, and what levels would jolt the ECB into easing interest rates.

The euro is heading up into territories where it can start to affect the European economic forecast. There may be some responses coming from the ECB to slow euro appreciation slightly, said Robert Fullem, vice president of U.S. corporate currency sales in New York at Bank of Tokyo-Mitsubishi UFJ Ltd.

Economic reports coming out this week may temper the euro's rise versus the greenback. The European Union's autumn report on the euro- area economy on Wednesday includes forecasts and policy analysis.

Weight of Northern Rock

The United Kingdom's economy has paid a noticeable price recently amid the dire situation for mortgage lender Northern Rock PLC. The affair may affect the credibility of U.K. macroeconomic authorities, said Paul Robinson, currency analyst with Barclays Capital in London.

In foreign-exchange terms, it is likely to increase the return investors will demand in order to hold sterling -- the risk premium on sterling -- and be associated with sterling depreciation, he said. Mr. Robinson forecasts the pound to soon settle below $2.

Financial services are the pound's key industry, and its troubles will add to the sterling's weakness, BNP Paribas analysts added in a research note.

In the U.S., some of the data currency investors will look to this week include durable-good orders for August and the final revision of the second-quarter gross domestic product.

But more important are data for existing and new home sales, tomorrow and Thursday, respectively.

Also closely watched will be an inflation indicator that is the Fed's preferred measure for gauging price pressures. The core personal-consumption expenditures-price index, which excludes food and energy costs, will be released Friday.

Inflation has emerged as a major concern among analysts this week, as the dollar's weakness is compared with rising oil prices and lower interest rates.

Write to Riva Froymovich at riva.froymovich@dowjones.com1

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