Hi Bobby; Thanks for the link...................
End of the Strong Dollar
at Hand?
Maybe in Europe, Not Asia
The dollar began to climb three years ago this week. It has hardly looked back since. Batch after batch of data confirmed the US economy as the star of the rich world. Whenever he was asked, Robert Rubin, US treasury secretary, would repeat his mantra: "A strong dollar is in the US interest."
Yet an era may be ending. This week the world's most heavily traded exchange rate, the dollar/ D-Mark rate, may have begun to turn. It dipped below the key DM1.80 rate. At the start of the month, it hit a peak of DM1.85.
Do not sell all your dollars yet, foreign exchange strategists say, but prepare to discover that the currency has peaked against the D-Mark. Michael Rosenberg, head of international fixed-income research at Merrill Lynch, the securities house, describes himself as "one of the few dollar bulls left". Philippa Malmgren, currency strategist at Bankers Trust, the investment bank, and a fellow bull, says: "The market sentiment is definitely shifting right now."
The shift seems confined to the dollar's value against the D-Mark and the European currencies that swim in perfect synchronicity with it. All things being equal, this would mean the dollar falling in trade weighted terms. But most strategists say that, against the yen, the currency of a shrinking economy, the dollar should keep going strong.
What underpins these currency movements? And, assuming they continue, what would they mean for the US and European economies?
If the D-Mark does rise, cheers in Europe may be muted. Germany seems to have no desire yet for a stronger currency - understandably, since the weak D-Mark has helped European exporters lead an economic recovery. Tellingly, European shares tend to fall when the currency rises. A stronger D-Mark would simply add to costs in high-wage German manufacturing. Yet a stronger D-Mark looks likely, if not today or tomorrow then within the next few months. The reason is that the European economic fundamentals are shifting.
For the past three years, the continent's stagnant economies and the doubts over economic and monetary union (Emu) have hurt the German currency. Now, things are different. Emu appears a done deal - it is expected to get its formal go-ahead early next month. And Europe is catching up with the growth rate in the US.
German economic growth accelerated to 3 per cent a year, and unemployment peaked last October at 11.8 per cent. Although Europe is hardly booming, everyone agrees the trend is moving the right way. By contrast, most economists think US growth will slow from its annual rate of about 3-3.5 per cent to about 2-2.5 per cent in the next six months.
Growth in Europe could push up European interest rates, making the D-Mark more attractive to yield-seeking investors. Germany's bell-wether interest rate, the repo rate, is now 3.30 per cent, but the market expects the Bundesbank to increase rates in the second half of the year. In January 1999, when the European central bank takes over monetary policy, it is expected to set its first repo rate at about 3.75 per cent.
Given that Spain, the Netherlands, Ireland, Finland and some other likely Emu founders are already growing far faster than Germany, European rates could then continue rising. Even while they remain below the US Federal funds rate of 5.50 per cent, their upward momentum should help the D-Mark.
The prospect of higher rates has already raised the yields on German government bonds, making them more attractive. The yield gap between 10-year US and German bonds has shrunk to about 80 basis points, just over half its level of a few months ago. The smaller this gap, the better the D-Mark tends to perform against the dollar.
Everything is going the euro's way, it seems. For years investors worried about whether Emu would happen, who would join it, and whether it would produce a weak euro. Those fears led them to seek safe havens in the dollar, sterling and the Swiss franc. Today, investors are confident that in eight days' time 11 countries will be selected as founder members of Emu. The fears of a collapsing euro have faded, now that even Italian inflation has dropped to barely more than 1 per cent.
Even the wrangle over who will run the European central bank is not scaring many investors away. "All European central bankers are now as rigorous and orthodox as each other," says Nick Parsons, currency strategist at Paribas Capital Markets, the French bank. Most investors expect the ECB to raise interest rates when it thinks this necessary without worrying what the politicians will say and regardless of who the chairman is. If so, that would tend to help the euro.
The other way Emu is likely to hit the dollar is by encouraging central banks and fund managers to keep more of their portfolios in euros. It is clear that both groups hold more dollars than their own guidelines tell them to. Just how overweight they are in the dollar was made apparent by Paribas last week. The bank said that central banks now hold 71 per cent of their $1,533.9bn reserves in dollars. That is 6 percentage points more than two years ago, despite the approach of Emu. That "over-investment" in dollars would imply a large shift into euros over the next year or more.
Since the dollar and the pound tend to move in tandem, any fall in the former would be likely to drag down the latter. That would relieve UK exporters and Tony Blair, the prime minister embarrassed by his inability to combat the rising pound. The comparison with the UK - where the fate of the currency has been a serious political matter - emphasises how little concern there is in the US over the dollar's rise.
It is true that the strong dollar has hurt US trade performance in the past few years. The trade deficit increased by nearly 6 per cent in the first two months of the year compared with a year earlier, and is likely to climb much higher. A rise in the current account deficit could lead to nervousness among investors about the long-term sustainability of the US external financial position. US manufacturers, particularly carmakers, have complained about the strong dollar.
However, there is no real political appetite for anything to be done about it. With unemployment near a 25-year low, even the most protectionist of politicians can hardly argue that the strong dollar is exporting US jobs abroad. Unlike in previous episodes of sustained dollar strength, US officials are showing few signs of alarm.
The American economy is relatively closed, with manufactured exports representing less than 10 per cent of gross domestic product. The US current account deficit is still at a manageable 2 per cent of GDP. Most important, US officials really believe what they say repeatedly in public: international currency movements in the recent past broadly reflect economic fundamentals and will only change when the fundamentals change.
All the same, the US is not adopting a completely hands-off policy towards the dollar. There is concern, in the administration especially, that other countries, particularly Japan, will use the strengthening of the US currency as a deliberate tool of policy to export their way out of their economic weakness.
Japan and the euro-zone countries, the US administration thinks, must not be allowed to think they can avoid the difficult structural reforms necessary simply by having their currencies weaken in international markets.
Yet no one expects to see the day that Mr Rubin sells billions of dollars in the market. If strong US economic fundamentals keep the dollar strong against the yen, he can live with that. And if strong German fundamentals drag down the dollar against the D-Mark, well, he can live with that too.
Financial Times, April 24, 1998 |
