No end in sight to greenback's misery

Top forecasters say the US dollar will keep dropping but others expect gains next year. Photo / Bloomberg

The most accurate dollar forecasters predict the world's reserve currency will continue sliding, even when the Federal Reserve begins to raise interest rates, which policy makers say is an "extended period" away.

Standard Chartered, Aletti Gestielle, HSBC Holdings and Scotia Capital say the US dollar will depreciate as much as 7.1 per cent versus the euro.

About US$12 trillion ($17 trillion) of fiscal and monetary stimulus, the world's lowest borrowing costs and a record US$4 trillion of government bond sales between 2009 and 2010 will weigh on the currency, they said. So will the nation's 10.2 per cent unemployment, and signs that the economic recovery may falter, they said.

"History tells us the dollar shouldn't start rising on a sustained basis until 12 months after the Fed starts to lift rates," said Callum Henderson, the Singapore-based global head of foreign-exchange strategy for Standard Chartered.

The best forecaster of the US dollar against the euro in the six quarters ended June 30 in Bloomberg's ranking of 46 firms last month predicts the greenback will weaken 5.9 per cent to US$1.58 against the euro in 2010, from last week's US$1.49 close.

"It'll take time to drain the oversupply of dollars from the market," Henderson said. "The dollar will remain weak until the Fed's rates rise above the competitors."

The US will be one of five economies represented in the Group of 10 to wait until after mid-2010 to raise benchmark rates, according to median predictions in Bloomberg surveys of as many as 60 economists.

The Fed, the European Central Bank, the Bank of England and the Swiss National Bank will increase borrowing costs in the third quarter. The Bank of Japan will remain at 0.10 per cent, at least through March 2011, the surveys show.

By the end of 2010, only Japan will have lower borrowing costs, and those will be higher when adjusted for inflation, the forecasts show. The Fed's target for overnight loans between banks will be 1 per cent, compared with the ECB's 1.5 per cent benchmark.

US borrowing costs will make dollar-based assets less attractive, said Camilla Sutton, the foreign-exchange strategy director at Scotia Capital in Toronto. The Bank of Nova Scotia unit, the most accurate forecaster of the dollar versus the Swiss franc in Bloomberg's rankings, predicts 2010 will end with the greenback weaker at US$1.60 per euro.

"The dollar will lose the near-term race for interest rate increases, and then lose the long-term race," Sutton said.

Once the Fed raises its target, the US dollar's performance likely will mimic the pattern that followed the central bank's past three rounds of increases, Sutton and Henderson said.

After the policy makers started boosting borrowing costs in July 2004, the Dollar Index tumbled 10 per cent and didn't get back to where it had been before the first increase, and stayed there for more than a month until November 2005.

Intercontinental Exchange's dollar gauge fell 6 per cent, and took seven months to recover after the Fed began lifting borrowing costs in July 1999. It dropped 16 per cent, following the Fed's 1994 move, without regaining lost ground until 1997.

The top forecasters are in the minority, with median predictions in Bloomberg surveys of as many as 43 strategists showing the dollar gaining against the euro, yen, Swiss franc and Swedish krona by September 30.

The other two currencies measured by the Dollar Index, the pound and Canada's dollar, will outperform the greenback by 0.3 per cent and 2 per cent, the projections show.

Twenty-four of 37 predictions for the end of next year have the US dollar strengthening against the euro. The median is US$1.47, up 1.1 per cent. Twenty-seven of 31 strategists see the yen also getting beaten. The US currency will gain 13.6 per cent to 101 from 88.88 on November 20, the median shows.

"The dollar will gain support as soon as the Fed starts to rein in liquidity," said Lee Hardman, an analyst in London at Bank of Tokyo-Mitsubishi UFJ, Japan's biggest lender by market value. The dollar will strengthen 10.1 per cent to US$1.35 per euro by the end of 2010, the bank predicts.

The stock rally that pushed the MSCI World Index up almost 70 per cent since March 9 will grind to a halt as the global recovery slows, spurring demand for the perceived safety of the dollar, according to Landesbank Baden-Wuerttemberg.

"Financial markets and equity markets have been too optimistic concerning economic growth next year," said Gernot Griebling, the Stuttgart bank's head of bond and economic research. "Risk aversion should rise again", strengthening the US currency to US$1.37 per euro by September 30, he said.

For now, the global recovery is on track, with the Paris-based Organisation for Economic Co-operation and Development doubling its 2010 growth forecast for leading developed economies to 1.9 per cent, and predicting a 2.5 per cent expansion for 2011. The recovery is fuelling investments in higher-yielding currencies, funded by selling dollars.

The Dollar Index has fallen 15.1 per cent since March 5, a steeper drop than in any eight calendar months in 23 years.

Fed Chairman Ben Bernanke said "significant economic challenges remain" in the US, and reiterated the Federal Open Market Committee will keep borrowing costs low for an "extended period".

Policymakers may not change course until 2012, Federal Reserve Bank of St Louis president James Bullard said.

HSBC, the top pound-dollar forecaster, and Aletti Gestielle, the best on the dollar versus the yen, also say the greenback will depreciate, to US$1.50 and US$1.60 per euro by mid-year, respectively.

The dollar will weaken "as investors worry about its status as a reserve currency and the public deficits," said Sutton.

The US budget deficit reached a record US$1.4 trillion in the fiscal year that ended September 30. Its debt amounted to 9.9 per cent of the economy, up from 2004's average of 3.5 per cent.

Central banks that disclose which currencies they hold put 63 per cent of their new cash into euros and yen in April, May and June, the highest percentage for any quarter when global reserves grew more than US$80 billion, Barclays Capital data show.

Henderson sees similarities to 2004, when the Fed had lowered its overnight target below the ECB's.

The 2001 recession, induced by the crash of technology stocks, prompted the US to cut rates by 5.5 percentage points to 1 per cent in June 2003, a point below the euro region. The Fed stayed there until June 2004, more than two years after the recession ended. The US dollar started rallying after the rate surpassed the ECB's 2 per cent that December.

"If the apex of the crises were in 2001 and 2008, then dollar weakness will last into 2011," said Henderson.

"When the Fed shifts from being dovish to the early stages of the tightening, the dollar continues to trade weak," said Ray Farris, global head of foreign exchange research at Credit Suisse Group in London, the third-best euro-dollar forecaster.

"It's really only in the late stages of a Fed tightening when US interest rates are high relative to everybody else that the dollar stabilises, and then recovers."

The dollar plunged to a record low US$1.6038 against the euro in July 2008 as seven Fed cuts opened up a 2.25 percentage gap to the ECB, making Europe's securities more attractive. It rallied later in the year as the collapse of Lehman Brothers Holdings in September froze credit markets, and sent investors to the safety of US assets and the greenback.

"There's nothing on the cards from a monetary policy angle that could persuade me from being a dollar bear in 2010," said Jens Nordvig, a managing director and head of G-10 currency strategy at Nomura International in New York.

- BLOOMBERG