Widening interest-rate differentials between the U.S. and Europe, uneasiness with U.S. finances and increased risk appetite are all likely to mean further weakness for the U.S. dollar this year.
Nevertheless, analysts caution there is potential for short-term stabilization or maybe even a correction as the dollar hits multi-month lows against many of the world’s major currencies.
“The trend is definitely leaning toward a lower dollar,” said Greg Michalowski, chief currency analyst at FXDD. “It does seem like the market has that set in its sights.”
As of late morning in New York, the dollar index hit a five-month low of 75.24, basis the nearby futures. The euro and British pound hit their highest levels against the greenback in more than a year, with the euro peaking at $1.4443 and the pound at $1.6427. The Australian dollar hit a fresh 28-year high of $1.0547.
Movement in the dollar often affects metals and other commodities, and numerous analyst research notes Friday attributed commodity-wide strength in large part to the sagging dollar. For starters, dollar weakness makes commodities cheaper for holders of other currencies and thus can boost demand. Also, investors often turn to gold and silver as an alternative currency or hedge against dollar weakness.
Early-year expectations for dollar strength have been reversed, analysts said. At one time, many anticipated fiscal and monetary stimulus would mean U.S. economic recovery that would lead to higher Treasury yields, thereby underpinning the dollar.
Further, the European sovereign-debt crisis was expected to further pressure the euro.
“It simply hasn’t played out that way,” said Robert Lynch, currency strategist with HSBC. “Authorities there have managed to stitch together policies or facilities that have provided some level of debt backstop for the peripheral bond markets. It hasn’t resolved stresses on an (individual country) state basis, but despite that, it hasn’t been an issue for the euro in the way that many people expected it would have.”
The euro also was underpinned against the dollar lately on anticipation that the European Central Bank would hike interest rates, which it did on Thursday. The ECB upped its benchmark interest rate by 25 basis points to 1.25%.
“Interest-rate differentials between the euro zone and the U.S. have widened in the euro’s favor since the beginning of this year, at least at the front end of the (yield) curve,” Lynch said.
Improved risk appetite has hurt the dollar against other currencies two ways, observers said. It means less flight to safety in the greenback. And, it means buying of so-called commodity currencies such as those of Canada and Australia.
Uneasiness about a potential U.S. government shutdown, due to gridlock over spending, has added further weight to the dollar, said Eric Viloria, senior currency strategist with Forex.com.
“The fiscal backdrop in the U.S. is not good and isn’t probably going to get better for a long time,” Lynch said. “But this more immediate issue of a potential government shutdown—partial, temporary or whatever it ends up being—is at the margin at least not good for a sentiment perspective for the currency.”
Analysts See Potential For Near-Term Stabilization, Then Further Dollar Weakness
Forex.com looks for some stabilization in the dollar for a while, even if there is not an actual bounce, Viloria said. “But then it could potentially continue to weaken,” he continued. “One of the main drivers would be monetary policy.”
Lynch said currently dollar weakness could be “overextended.” But, he continued, “just because something is overextended doesn’t mean it can’t get (further) overextended before it begins to normalize.” But even if the dollar corrects some, the “troubling” fiscal backdrop portends further weakness, he said.
Michalowski looks for the euro to run into some short-term resistance around the $1.45 area, but if this fails, could mean a move to the next level at $1.4750 to $1.4800.
Foreign-exchange trading tends to favor the currency of a country hiking interest rates over one that isn’t. After Thursday’s hike, ECB President Jean-Claude Trichet was non-committal on future increases.
“But I think the market is pretty much convinced if they raised rates because of inflation this month, inflation isn’t necessarily going to go away with oil prices even higher now,” Michalowski said. “And so, the ECB is going to be continually concerned about inflation and this is likely to lead to further tightening down the road.”
Lynch and Viloria said expectations are for the ECB to undertake at least two more 25-basis-point hikes yet this year. Michalowski anticipates a rate each 2 ½ months or so, meaning three more for the year, with the possibility of four.
Money-market rates have already factored in the further ECB tightening currently expected, Lynch said. Still, the higher European rates will remain a supportive influence for the euro.
Meanwhile, expectations are the Federal Reserve’s policy will remain accommodative for some time yet. Policy-makers are expected to continue with Treasury-asset purchases through the end of June, as scheduled, under a quantitative easing program intended to push down long-term interest rates when short-term rates are already nearly zero. With this program in place, economists figure it will be some time yet before the Fed actually hikes rates, even if it does not undertake another round of quantitative easing.
There have been hawkish rumblings lately by some Fed officials. But often, these have been from non-voting Fed officials, with the majority of voting members still perceived as dovish, Viloria said. “The easy monetary policy is likely to continue for a while,” he said.
Michalowski said as investors become more comfortable with the so-called “risk-on” trade, this will mean move into higher-yielding currencies such as the Australian dollar, particularly as economic growth continues to indicate strong commodity exports. This should also mean strength for emerging-market currencies, particularly due to potential for these central banks to hike rates to cool growth and inflation.
Lynch listed U.S. finances as a factor that could mean further pressure on the dollar. He pointed out that the current spending battle between Republicans and Democrats is over just 2% of all federal outlays for the year. “You’re not talking about the kind of money that represents material improvement in the fiscal backdrop here,” Lynch said. “So I think that still represents a real threat to the dollar going forward.”
Still, there are always numerous cross-currents in the foreign-exchange market, and some could always shift into the dollar’s favor. A potential one would be the ongoing debt issues in peripheral Europe, currently shrugged off by forex traders.
“That could rear its head if more banking problems start to emerge,” Michalowski said. This especially could be the case if the debt troubles that plagued Greece, Ireland and Portugal become more pronounced in Spain. “They are a larger economy within the EU (European Union),” he said.
Source: Kitco News
