The Dollar Is Poised for Moderate Lift

The US dollar steadied Wednesday, January 5, after its biggest surge since mid-2004 began to correct the year’s end weak performance against the Japanese yen and the euro. Still, most big banks and investment houses are predicting its continuing slide in 2005 too. debkafile‘s financial expert is cautiously optimistic. In his view, the decline may have hit bottom and a slow recovery is in store over the next two or three months.
The causes of the dollar’s 8% slump against the euro (23% accumulated weakness last 2 years); 4% against the Japanese yen, are well known, primarily America’s huge trade and current accounts deficits. Some experts are predicting a further 20-30 % plunge in the dollar’s value this year to balance out the trade deficit (a weak dollar equals greater American exports). Another contributing cause was the action of some central banks, notably in China, Korea, India, Taiwan and also Russia, to diversify some of their reserves, switching part of their dollar holdings mainly to the euro.
Then too, the first Bush presidency appeared comfortable with the weak dollar and fatalistic about the budget strains resulting from big spending, particularly on the Iraq war. Treasury secretary John Snow took no real steps to remedy the dollar’s descent and was in fact accused of mixed messages on the issue. He was apparently following his boss’s lead. President George W. Bush voiced the view that the dollar rate should be determined by free market movement. If this view persists in the second term, then direct action, such as the Federal Reserve stepping in and buying dollars, is unlikely to happen.
These and other trends and arguments have persuaded most analysts and investors to conclude that 2005 will see more of the same – that is a feebly-flailing dollar which may slip further.
debkafile‘s financial analyst does not argue with the surface trends but sees in the initial signs of correction manifested this week a symptom of partial recovery, however volatile, in the weeks to come.
It will be helped along if the Fed continues to edge up short-term 2.25% interest rates by more than 2% in 2005. A better interest yield may encourage investors to hold onto dollars – although in the past, higher interest rates did not always benefit the dollar.
The US currency will get its most important boost from favorable American economic figures – the first of the second Bush presidency. A steady spiral of recovery, growth and new jobs in the American labor market will have its effect. New unemployment figures out Friday, January 7 are important to watch.
America’s biggest trade deficit is with China and therefore much of what happens to the dollar is also contingent on the Chinese factor. For a decade now, the Chinese currency has been pegged at 8.28 yuan to the dollar. It is the only world currency that has not gained against the dollar’s depreciation notwithstanding demands from Washington to let the yuan fluctuate and reduce the US trade deficit.
The Chinese yuan cannot be traded today on open markets, but trading on its forward rate (NDF= non-delivery forward) points to a 5% rise against the dollar within a year. No one is prophesying if and when the yuan will be revalued, but if it were, it would be good news for the dollar against other currencies.
The Europeans and Japanese see themselves as victims of the weak dollar which fuels US exports at the expense of their own. Still, President Jean-Claude Trichet of the European Central Bank (ECB) advises foreign exchange markets to avoid “brutal” steps, warding off demands from European leaders Chancellor Gerhard Schroeder and Italy’s Berlusconi to cushion their industries and exports against the inroads of the falling dollar.
But while the European record of intervention in the foreign exchange markets is anemic, Japan’s is aggressive. From September 2003 to March 2004, Japan’s central bank (BOJ) bought hundreds of billions of dollars to hold the Japanese yen down in order to sustain recovery and growth. Since March, there have been no further BOJ interventions. But last week, Japan`s finance minister Sadakazu Tanigaki warned the yen would not be permitted to gain inordinately and Tokyo stood ready to step into the markets again to flatten any upward curve of the yen without delay.
That several central banks may get together for intervention to slow down any further dollar dips – even without the Fed – is also on the cards. Such action might even generate a temporary lift.
All in all, the currency markets are ripe for a dollar boost. Some indicators show the market as being more than ready for a technical correction that adjusts the dollar-to-euro imbalance to a healthier 1.30-1.32 dollars per euro.
In Israel, the currency mirrors fluctuations in the national security situation and the stability of government. Down from NIS4.62 per dollar in May 2004 to hover around NIS4.30 in recent months, in Israel too the dollar surged to NIS4.40 Wednesday, January 5. The approaching Palestinian Authority election and the Sharon government’s settlement withdrawal plan due to go into effect in the second half of 2005 are both expected to generate turbulence and uncertainties that will drive investors away from the shekel to find refuge with the dollar. debkafile‘s financial analyst predicts a leveling out in the coming weeks at NIS4.45 per dollar.