Dollar may face renewed pressure

/ Source: Financial Times

Some foreign exchange analysts say the dollar is likely to come under more selling pressure in the weeks ahead, defying the usual pattern of December being a quiet month in the currency markets.

The recent decline in the U.S. currency, particularly against the euro and yen, has been long awaited by many economists, who say it could help to rebalance the global economy and reduce the large U.S. current account deficit. And though the slide has been quite rapid, it has also been relatively smooth, raising hopes that the transition to a lower dollar can be managed without disruption and volatility.

The euro rose as high as $1.217 on Friday against the dollar after a disappointing US employment report reduced some investors’ expectations of a near-term rise in interest rates. The slide in the dollar in recent months has come despite a string of economic data releases showing increasing strength in the U.S. economic recovery, to which Friday’s jobs data were a mild exception.

Analysts say that a series of tactical incentives for market participants is likely to put the dollar under further pressure in the weeks ahead. Foreign exchange economists say that European companies with dollar earnings due next year are busy protecting their revenues in euro terms by hedging against further falls in the U.S. currency, putting more downward pressure on the greenback. “A lot of them missed the euro’s rise this year and, for those with a requirement to put on hedges before the year-end, this will force them to buy euros,” said Nick Parsons, head of currency strategy at Commerzbank.

Though December is traditionally viewed as a quiet month in the foreign exchange markets in which fund managers square their books, last year the dollar fell by over four cents against the euro between the beginning of December and the new year. Analysts said that, having been caught out last year, fund managers were unlikely to wait until after the Christmas break to sell dollars this year.

The Federal Reserve Open Market Committee, which meets on Tuesday to decide on interest rates, may marginally increase its optimism about the economic outlook in the statement it releases after the meeting. But with Fed officials insistent that any rise in interest rates is some way off, the FOMC is unlikely to give much help to investors looking for higher yields on U.S. bonds to support the dollar.

In a recent speech, Alan Greenspan, Fed chairman, said that at some point the willingness of foreign investors to continue funding the U.S. current account deficit would diminish. But he said that the flexibility of the U.S. economy and financial markets was likely to ease the transition.

“To be sure, the real exchange rate for the dollar has, on balance, declined roughly 20 per cent against the major foreign currencies since early 2002,” Mr. Greenspan said. “Yet inflation, the typical symptom of a weak currency, appears quiescent.”

Mr. Greenspan referred to a Fed study in which the average current account deficit in rich countries since 1980 had risen to 5 per cent - the present level of the U.S. deficit - before foreign investors balked at funding it. “Although the large majority of episodes were characterized by some significant slowing of economic growth, most economies managed the adjustment without crisis,” he said.