April 27, 2007 / 8:34 PM / 13 years ago

U.S. dollar slumps and this time it's different

NEW YORK (Reuters) - The last time the U.S. dollar slid to a record low against the euro it quickly recovered, but this time may be different.

In this file photo an Indonesian activist covers her mouth with mock U.S. dollar currency during a protest outside Singapore's embassy in Jakarta September 15, 2006. REUTERS/Supri

The dollar slid to a new record low against the euro on Friday, with the euro quoted above $1.3680, the highest since the currency’s launch in 1999.

When the euro climbed above $1.36 in 2004, it limped above that level for five days, and then embarked on a year-long decline.

But unlike late 2004, when the Federal Reserve was in the early stages of a two-year rate rising cycle which provided some support for the dollar against the euro, U.S. economic growth is now slowing and the Fed may even cut interest rates later this year.

At the same time, economies in the Europe and Asia seem to be weathering the U.S. slowdown well, suggesting that interest rates in those regions may continue to move higher, drawing yield-hungry investors away from the dollar.

“I think we’re going to see $1.38 (euro/dollar) without too much trouble here,” said Joseph Trevisani, chief market analyst at FX Solutions, an online currency dealing platform based in Saddle River, New Jersey.

The immediate trigger for the dollar’s fall on Friday was a report showing that the U.S. economy grew at its most sluggish pace in four years during the first quarter.

But the writing had been on the wall for months now, as the dollar’s appeal to yield-hungry investors was on the wane.

Two-year U.S. Treasury notes US2YT=RR are yielding just half a percentage point more than government debt of the same maturity in the euro-zone, the lowest interest rate differential since late 2004, and well below a peak of around 1.8 percentage points in the middle of 2006.

By contrast back in late 2004 differentials were actually widening in the dollar’s favor as yields on euro-zone debt were falling on worries that the strong euro would strangle the European economy.

In 2004 Jean-Claude Trichet, head of the European Central Bank, was also warning that the euro’s rise was “brutal” and “unwelcome”, a signal that it could be risky to chase the currency higher.

In contrast euro zone officials appeared almost nonchalant on Friday. The Eurogroup’s Jean-Claude Juncker said he was not concerned about the level of the euro, which has also hit repeated record highs against the yen in recent weeks.

THAT WAS THEN, THIS IS NOW

And the contrast with 2004 does not end there. This time around the market appears to have greeted the euro’s spike to a fresh record high with a big yawn.

One-month implied volatilities on euro options were trading around their lowest level in 5 months on Friday.

At just above 5 percent, volatility is little more than half the level that is was in late 2004.

Many analysts reckon that the dollar’s slow but steady grind lower is set to continue. Slowing growth and the prospect of lower interest rates is likely to rekindle concerns about the United States’ ability to finance its gaping current account deficit, which requires $2 billion a day to plug.

Over the coming three to six months, the euro looks on course to rally to $1.40 or higher, said Nick Bennenbroek, head of currency strategy in New York for Wells Fargo.

Stubbornly high readings on inflation are another reason to bet against the dollar, some investors reckon.

“Growth is slowing and inflation is rising. The Fed cannot raise rates because growth is slowing ... that’s negative for the dollar,” says Bill Lipschutz, portfolio manager at Hathersage Capital Management, a currency hedge fund.

The implicit price deflator, one gauge of inflationary pressures in Friday’s GDP report, jumped at a 4.0 percent rate in the first quarter, the biggest jump since early 1991.

This week the dollar fell to its lowest level ever against a basket of major currencies tracked by the Fed since 1973.

However the dollar’s decline has been unevenly distributed. Since a peak in mid October it has fallen 9.5 percent against the Australian dollar, 8.0 percent versus the euro, 7.0 percent against sterling, but is virtually flat against the yen.

Some longer-term investors say the dollar’s sharp decline is starting to make it look attractive again against European currencies like the euro and sterling.

“Let’s face it, the dollar has had a good sell-off, but in terms of valuations it is now looking to be one of the cheaper currencies out there,” says Roddy Macpherson, investment director of global strategy at the UK-based Scottish Widows’ Investment Partnership, which oversees $200 billion of funds.

Macpherson says he reckons the dollar is around 20 percent undervalued against the British pound and the euro.

But most shorter-term investors don’t have the stomach to bet on a dollar rebound just yet, especially ahead of some blockbuster U.S. data releases next week, including readings on inflation and a monthly jobs report.

More weak data “would effectively give a “green light” to continue selling USDs and quite likely the catalyst to break above the 1.3700 threshold in the EUR/USD,” said Michael Woolfolk, senior currency strategist at Bank of New York.

Additional reporting by Kevin Plumberg

0 : 0
  • narrow-browser-and-phone
  • medium-browser-and-portrait-tablet
  • landscape-tablet
  • medium-wide-browser
  • wide-browser-and-larger
  • medium-browser-and-landscape-tablet
  • medium-wide-browser-and-larger
  • above-phone
  • portrait-tablet-and-above
  • above-portrait-tablet
  • landscape-tablet-and-above
  • landscape-tablet-and-medium-wide-browser
  • portrait-tablet-and-below
  • landscape-tablet-and-below