ETF Investment News & Articles

Dollar to Rally – Or Retreat

Market Watchers Say Big Move Is Due but Can't Agree on Direction

July 29, 2004; WSJ, Page C14

PARIS -- For a market that promised to be full of pizzazz when the year began, the $1.2 trillion-a-day global foreign-exchange market has been stoic as a mule. Instead of falling steeply further, as most analysts predicted, the dollar is higher against most other major currencies and down less than 2% against the pound.
Moreover, its major rival -- the euro -- for much of 2004 has floundered in a range of $1.1780 to $1.2460.
Even so, that hasn't stopped economists, strategists and other prognosticators from predicting that a big breakout for the dollar is imminent -- and that a big rally or a big retreat is in store. Needless to say, they disagree on which. But it is a key question as the U.S. currency yesterday climbed to six-week highs against the euro and yen, its highest level in two months against the Swiss franc and was near a one-month peak against the pound and the Australian dollar. Its recent rise was helped by unexpectedly upbeat comments last week by Federal Reserve Chairman Alan Greenspan about the U.S. economy and inflation.

Few average investors spend their time trying to play the foreign-exchange markets, and rightly so. But they should care about the dollar's direction.

Even the relatively small shifts in currencies so far this year have had an impact on other investments. Take the German stock market. This year through Tuesday, it is down 4.8% in euro terms, according to Morgan Stanley Capital International. But to an American who tallies wins and losses in dollars, that deficit widens to 8.9% because the dollar has strengthened since the start of the year. Similarly, the Tokyo market's 5.3% rise expands to 6.4% for a resident of one of the 12 euro-zone countries, but shrinks to 1.8% in dollar terms.
First, the case for the dollar doomsayers, who see a big slide ahead. In six months, Steve Barrow, the chief currency strategist for Bear, Stearns & Co. in London, expects the dollar to be trading at $1.30 to the euro, ¥100 and $2 to the pound. His 12-month forecast is even more dollar-negative -- at $1.36 to the euro, ¥90 and $2.03 to the pound.

Late yesterday in New York, the euro was at $1.2046, down slightly from $1.2049 late Tuesday, and the pound had risen to $1.8252 from $1.8212. The dollar strengthened to ¥111.69 from ¥110.96.

The core of the bears' case rests on what economists like to call the U.S.'s "structural imbalances." In particular, they point to the huge deficit in the U.S. current account, a broad measure of trade in goods and services plus certain financial transfers. Running at an estimated $550 billion to $580 billion, it equals roughly 5.1% of U.S. gross domestic product. And because Americans don't save enough, the U.S. must rely on foreigners to fund the shortfall, mostly through direct investments, the purchase of U.S. assets and bank loans. Thus, bears argue, U.S. investments must yield enough to persuade foreigners to keep buying them, or the dollar must sink lower.
" There appeared to be reluctance among private-sector investors to buy U.S. assets in the period preceding U.S. rate hikes," says Mark McFarland, a currency strategist at UBS in London. "This bodes ill for the dollar." Adds Barbara Rockefeller, president of Rockefeller Treasury Services in Southbury, Conn.: "The doom-and-gloom crowd says it's a crisis in the making."

But at ABN Amro Bank, strategists are looking for the euro to fall to $1.15 in three months and $1.10 in a year, while the pound trades down to $1.78 in three months and $1.64 in 12 months. Strategists at Bank of Tokyo-Mitsubishi predict the dollar will climb to ¥115 in six months and ¥118 in 12 months.

Their case rests largely on cyclical factors, such as changing estimates of economic growth and interest rates.
Who wins in the end? In the short run, usually the cyclical argument prevails, says Ms. Rockefeller. Her advice: "Accumulate dollars when they are still cheap, but get ready to jump back on the trash-the-dollar bandwagon."