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April 17, 2013 12:08 am
Less than 48 hours after Barack Obama was inaugurated in 2009, Tim Geithner, the president’s choice to be US Treasury secretary, said a strong dollar was in the country’s interest.
Four years ago, that statement – first used by Robert Rubin, a former Treasury secretary, in the 1990s – was taken with a great deal of scepticism. The dollar had to that point lost 40 per cent of its value versus the euro and the Obama administration was on the verge of borrowing over $2tn to spur the US economy out of its worst crisis in decades.
Fast forward to the start of 2013 and the administration may very well witness a rebound in the US currency. As the world’s largest economy emerges from the recession in better shape than most developed nations, the greenback is taking off.
A string of upbeat economic data, including a robust jobs report for February, have pushed the 10-year benchmark Treasury yield closer to 2 per cent and left the benchmark S&P 500 index poised to challenge an all-time record high.
On a trade-weighted basis, the world’s foremost reserve currency has gained about 4 per cent since the start of the year in tandem with so-called risky assets such as equities. The euro, sterling and the Japanese yen have retreated.
“What’s been happening to the US economy is having a positive impact on the US dollar,” says Joe Manimbo, a senior market analyst at Western Union Business Solutions.
“That has not been the case for quite some time. In fact, better economic news and less global risk aversion have tended to hurt the dollar in the past couple of years.”
The US outperformance is also highlighting the role of interest rates to foreign exchange markets. In a yield-starved world, the slow rebound in US benchmark interest rates is attracting more foreign investors wanting to own dollar-denominated assets that generate higher returns.
Even as the Federal Reserve has been heavily buying US Treasury bonds under its quantitative easing programme, yields have been rising against those of other debt such as German Bunds and Japanese government bonds, boosting the dollar’s allure.
In March, US 10-year yields rose to their highest premium since August 2011 against much lower Japanese yields. The difference between German and US Treasury 10-year yields hit its widest mark since the summer of 2010 as markets price in fast US growth.
“It’s been an interesting year, with a remarkable breakdown in the negative correlation between risk and moves in the US dollar,” says Vassili Serebriakov, a foreign exchange strategist at BNP Paribas.
“While the current Fed policy is a given, there’s a lot more optimism about the US and positive sentiment towards US assets, including the dollar.”
Some analysts warn this divergence in bond yields may not last and the recent dollar advance could prove temporary. Christopher Rupkey, chief financial economist at Bank of Tokyo-Mitsubishi in New York, says investors looking for a firmer signal of sustained dollar strength should wait for it to rally against a broader pool of currencies, including those of emerging nations.
“Interest rate differentials can help the dollar only so far,” he says. “The Fed wants to keep rates low for quite some time, and while the US GDP is giving the dollar an advantage over the euro, much of that is predicated on the eurozone economy remaining fairly weak. It’s hard to see the dollar rally going much further once the European economy improves.”
The last two big periods of dollar ascendancy occurred in the early 1980s and mid-1990s. Those bull runs were marked by a starting point where the dollar was valued cheaply against the backdrop of an improving domestic economy and rising interest rates. The dollar index is a third below its 2001 peak.
Others, such as Donal O’Mahony, a global strategist at Davy Capital Markets, note that aggressive monetary easing by other major central banks, in particular the Bank of England and the Bank of Japan, has also contributed to recent gains in the greenback.
“The US economic growth gives the dollar a bit of an edge, particularly against the euro,” he says. “But we have a couple of major central banks in places like the UK and Japan, whose currencies are important counterparties for the dollar. And their policy preference is for currency weakness. In a certain way, the dollar is improving against such currencies by default.”
The outlook for the dollar throughout the rest of the year will depend heavily on whether the Fed continues with its large scale bond-buying programme, and for how long. An anticipation of an end to quantitative easing has contributed to the currency’s recent strength, but renewed eurozone worries also played a part, analysts said.
Aroop Chatterjee, foreign exchange strategist at Barclays, believes the US dollar is getting set to rally, with the bulk of the moves coming later in the second half of the year as markets price in Fed tightening expectations.
“The stars have already begun aligning for a US dollar rally,” he says. “Our current set of forecasts has the US dollar appreciating by about 4 per cent versus the rest of the world over the coming year.
“This is a reasonable outcome given the relative outperformance of the US economy, the unlikelihood of further improvements in market risk appetite, and higher US interest rates.”
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