Gold is never a buy but the KingBuck is...
>>July 6, 2001
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Foreigners' Confidence in U.S. Economy
Keeps Dollar Strong Against Currencies
By MICHAEL R. SESIT
Staff Reporter of THE WALL STREET JOURNAL
LONDON -- For the third year running, 2001 was supposed to be the year the dollar finally took a fall against the euro and other currencies. But half way through the year, the dollar remains strong and is widely expected to make further gains in the months ahead.
What gives?
The basic answer is that foreigners retain a nearly unshakeable faith in the U.S. economy. They keep investing money in America, confident that returns there will be higher than most other places and risks lower. This faith in America and the dollar has survived the crash of Nasdaq stocks, slowing U.S. economic growth, lower U.S. interest rates and the continuing dismal U.S. trade performance.
Read the full text of Wim Duisenberg's statement after the ECB's decision to hold interest rates steady.
Those investments, in the form of stocks and bonds as well as corporate acquisitions, generally involve people outside the U.S. exchanging their local currencies for dollars, bidding up the dollar's value.
Meanwhile, many investors remain wary of the euro, an amalgam currency created only 30 months ago and one that still hasn't stood the test of time.
On Thursday, the U.S. currency climbed to highs for the year of 83.57 U.S. cents to the euro and 1.8205 Swiss francs. It also rose to a three-month high of 125.80 yen. The euro's low brought the currency to within a cent and a half of its all-time low of 82.28 cents, set on Oct. 26. At the current rate, Europe's common currency is about 29% below the level at which it made its debut on Jan. 1, 1999.
"It was the usual combination of all the wrong things at the wrong time," James McCormick, a currency strategist at J.P. Morgan, said of the euro's fall Thursday.
He said the dollar benefited from higher-than-expected German unemployment data, underscoring the recent abrupt slowing of the European economy. Mr. McCormick also cited the European Central Bank's decision not to cut interest rates, a step that might have spurred the economy. Also souring the mood was the rejection this week by the European Parliament of a long-awaited common takeover code, a reminder of the difficulty of reaching consensus in the European Union.
How long can the dollar stay aloft? "There is absolutely no sign of the dollar trend against the euro leveling out, much less stopping or reversing," said Tony Norfield, global head of foreign-exchange research at ABN-Amro Bank in London. "The end of a trend is normally indicated by signs of speculative excess, and there is no such sign in the dollar's rate against the euro." He predicts the euro could fall to 75 U.S. cents over the next 12 months, compared with 83.60 in Thursday afternoon trading in New York.
So-called structural factors provide long-term support for the dollar, analysts say. "The U.S. economy is considered flexible, dynamic and productive; that contrasts with a view of Europe as a region burdened with high taxes, labor and product rigidities and bloated bureaucracies," said Jane Foley, a currency strategist at Barclays Capital in London.
Some analysts saw fresh evidence of such rigidities in the rejection of the proposed common code to regulate takeovers in the EU, legislation that has been debated for more than a decade. The defeat "again reinforces the market's perception that not only structural rigidities in terms of labor markets and tax regimes, but also political interference will curb the potential scale of foreign direct investment inflows into Euroland," Michael Lewis, a director of currency research at Deutsche Bank, told clients in memo.
At the same time, U.S. investment inflows remain strong overall. Based on first-quarter data, 2001 annualized foreign-direct investment should fall to $34 billion (40.19 billion euros) from $135 billion last year. But net-equity inflows will rise to $62 billion and fixed-income inflows to $439 billion from $76 billion and $208 billion respectively.
On a shorter time horizon -- say, three to six months -- the dollar should be buoyed by perceptions that the U.S. economy is close to bottoming out, while the European and Japanese economies continue to deteriorate, says Steven Englander, global currency economist at Citibank.
The Federal Reserve's six interest-rate cuts totaling 2.75 percentage points this year have persuaded many investors that the U.S. central bank has the tools to rev up the American economy. By contrast, the European Central Bank, which has cut rates only by a quarter-percentage point -- and left them unchanged -- is widely regarded as having credibility problems and not doing enough to address the 12-nation euro-area's slowing growth.
Investors have also acted on U.S. Treasury Secretary Paul O'Neill's stance that the U.S. government supports a strong dollar. That keeps foreign investors secure that the value of their U.S. assets won't decline while their money finances the huge deficit on the U.S. current account, a broad measure of trade in goods and services plus certain financial transfers.
Still, many analysts argue that the dollar can't remain strong indefinitely. That's mainly because Americans don't save enough to finance the estimated $440 billion deficit, equal to more than 4% of U.S. gross domestic product, in its current account. "A yawning trade deficit is a persistent source of weakness to the U.S. currency," said Stephen Lewis, chief economist at Monument Derivatives.
Paul Meggyesi, an analyst at Deutsche Bank, pointed to a 40% fall in net foreign purchases of U.S. bonds in April, a plunge in equity inflows to the U.S. so far in 2001 and a steep decline in merger and acquisition activity, which so strongly supported the dollar in 1999 and 2000. Thus, he said, "the most recent flow data reveals a few chinks in the dollar's hitherto impregnable armor."
Although Citibank forecasters are still bullish on the dollar, the currency's anticipated surge over the next few months could be the its last hurrah, Mr. Englander said. Like Mr. Meggyesi, he sees the three pillars of U.S. capital inflows -- stocks, bonds and foreign direct investment -- delivering less oomph than they did in the past.
"We are increasingly concerned that once a U.S. economic recovery is fully reflected in U.S. asset prices, foreign investors will become less willing to buy American assets than in the late 1990s, when U.S. productivity growth and corporate profits consistently surprised on the upside," Mr. Englander said. "And if the recovery is only moderate, foreigners may feel they have purchased sufficient U.S. assets."
Mr. McCormick of J.P. Morgan, added that with the Fed nearly finished cutting interest rates, "but a recovery in corporate profits still nowhere in sight, it's hard to imagine that foreigners will keep gobbling up U.S. bonds."
Meanwhile at the ECB, hope springs eternal. "I cannot explain fully as I have said on many occasions the level of the euro at any particular moment ... all the factors that we have mentioned in the past explaining the depreciation of the euro now seem to have reversed," said ECB President Wim Duisenberg. "Yet it has not had an impact yet on the exchange rate of the euro. But we remain convinced that the euro -- and that's not an empty slogan -- has indeed a strong potential to appreciate."<< |
