US dollar under pressure

May 15, 2009 — Mitul Kotecha

The US dollar has come under major pressure, with the US dollar index (a composite of the dollar against various currencies) falling to 4-month lows.   The weakness of the US dollar has been broad based and even the Japanese yen which normally weakens as risk appetite improves, has strengthened against the USD.  The euro has also taken advantage of dollar weakness despite ongoing concerns about the European economy. The main source of pressure on the dollar is the improvement in market appetite for risk.  

As I noted in a previous post, “What drives currencies?” risk appetite has been one of the biggest drivers of currencies in the past year.   This has pushed other drivers such as interest rate differentials into the background.   In the post I also stated that we would all have to watch equity markets to determine where currencies will move, with stronger equities implying a weaker dollar.

The dollar looks particularly sickly at present and it is difficult to go against the trend.  It will need a major reversal in equity markets or risk appetite to see a renewed strengthening in the dollar.   Although I still think it will require some positive news as opposed to less negative news to keep the momentum in equity markets going (see previous post) the prospects for a stronger dollar remain limited.   

Over the coming months the dollar is set to weaken further and those currencies that have suffered most at the hands of a strong dollar will benefit the most as risk appetite improves.  It is no coincidence that the UK pound has strengthened sharply over recent days, and this is likely to continue given its past undervaluation.  Other currencies which were badly beaten such as the Australian dollar and Canadian dollar will also continue to make up ground, helped too by a rebound in commodity prices.   

Aside from improving risk appetite the dollar may also come under growing pressure from the Fed’s quantitative easing policy, especially if inflation expectations in the US rise relative to other countries as a consequence of this policy.  It will be crucial that the Fed removes QE in a timely manner and many dollar investors will be watching the Fed’s exit strategy closely.  

Although the US trade deficit is showing improvement another concern for dollar investors is the burgeoning fiscal deficit.   The US administration revised up its estimate for the FY 2009 deficit to $1.84 trillion or about 12.9% of GDP, highlighting the dramatic deterioration in the US fiscal position.  Concerns about this were highlighted in an FT article warning about the risk to US credit ratings.

The deterioration in dollar sentiment has also been reflected in speculative market positioning, which has seen speculative appetite for the dollar drop to its lowest level in several months. The bottom line is that any recovery in the dollar over the coming weeks is likely to be limited offering investors to take fresh short positions as investors continue to move away from holding the dollar.

Posted in central banks, Commodities, Currencies, Economics, equity markets, Europe, Financial crisis, US, US administration. Tags: , , , , , , , , , , , , , , , , . 6 Comments »

Not all doom and gloom in the UK

May 6, 2009 — Mitul Kotecha

There is a particularly depressing headline in the UK Telegraph stating that Britons will have to work until the age of 70 to bring public debt under control.  The NIESR who made the prediction believes that the UK will have to take drastic measures such as raising the retirement age, drastically raising taxes, and/or sharply cutting spending to reduce the debt burden in the wake of government borrowing plans amounting to £175 billion (see A taxing time in the UK).  

All of these look unpalatable but there is little choice otherwise future generations will have to pay a heavy price and/or investor demand for government debt could collapse.   At the same time the NIESR forecasts that the UK economy will drop by a whopping 4.3% this year, which is more pessimistic than government forecasts.   

The size of the debt burden is clearly distressing but by now most of us have likely got over the shock of the budget announcements.  Although the issue will not go away quickly attention is turning to some positive signs emerging in the UK economy and the housing market.  For instance, amidst the gloom of the NIESR predictions they also forecast that the economy will begin to grow again in the fourth quarter of this year.   

There was also a separate report just released showing that UK consumer confidence rose the most in close to 2-years according to the Nationwide.  Importantly, the gauge of future expectations rose sharply, suggesting a recovery in the months ahead.  Added to evidence that mortgage approvals have risen to a 10-month high, whilst manufacturing and service sector confidence have improved, it looks as though the economy and the housing market are finally beginning to bottom out.    

All of this will take some of the pressure off the Bank of England but it does not mean that the BoE’s £75 billion asset purchase plan will be scaled back any time soon.   Moreover, interest rates are likely to remain on hold at the low level of 0.50% for several months to come, which in turn is good news for consumers and borrowers alike.   So, perhaps its time to shake off the gloom and look ahead as the worst for the beleaguered consumer has likely passed.

Posted in central banks, Economics, UK. Tags: , , , , , , . 2 Comments »

What drives currencies?

April 7, 2009 — Mitul Kotecha

Currency forecasting is never an easy thing to do. The drivers of currencies appear to change over time making it quite tough to develop forecasting tools with great accuracy. This is not an excuse from someone who has been trying to analyse currencies for a number of years but just a statement of reality. Over the past year or so one of the biggest drivers of currencies has been risk appetite. As equity markets sank in 2008 the main winners were the dollar and yen both of which appreciated due to strong repatriation flows and safe haven demand. This influence of risk in determining currency movements saw historical influences such as interest rate differentials pushed into the background.

Where does it leave FX now? Well, if the rally in equity markets continues it implies that both the dollar and yen will fall further whilst long suffering currencies such as the pound will strengthen further. In the pound’s case it has a lot of room to recover given that is massively undervalued by many measures. For instance during my time in Hong Kong the pound against the dollar has dropped by around 30% making things look far more expensive than when I first came. However, to a foreigner UK assets now look quite well priced and London is no longer such an expensive city. Add in the steep drop in house prices and the UK looks even more competitive. This will no doubt benefit the economy in time.

So if the current risk/FX relationship holds it means that we should all be watching equity markets to see where currencies are going to move over coming months. If equity markets fail to sustain their rally it could put the dollar back on the front foot which will see the pound back under pressure. Eventually the dollar will weaken as risk appetite improves and when that happens the pound may be one of the main beneficiaries.

Ps. I hope this works as I am posting this article on holiday. It also means that my contributions may be a bit more sporadic over the next couple of weeks.

Posted in Currencies, Economics, equity markets, Financial crisis. Tags: , , , , , , . 4 Comments »
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