17 April 2001, 14:34 The focus in FX markets
NEW YORK (MktNews) - The focus next week in FX markets is sure to
shift away from a behind-the-curve ECB and on-going Japanese political
wrangling, and center instead on hard U.S. economic releases and their
implications for the U.S. economy and the dollar.
The week brings a slew of data: CPI, Industrial Production,
Capacity Utilization, International Trade, Leading Indicators and the
Philadelphia Fed consumer index.
Judging from the reaction from Thursday's weak economic data,
analysts will be eager to jump on any signs of further economic downturn
and cry for the Fed to act pre-emptively, with an inter-meeting rate
cut.
Trying to discern what all this means for the U.S. currency is a
hefty task for most Foreign exchange traders and analysts.
"Since 1973, economists have tried to find consistent links between
currency performance and economic variables," said analysts at Brown
Brothers Harriman in their quarterly review.
"Inflation differentials, yield differentials, yield spreads,
liquidity indices and balance of payment trends (to name a few) have all
been shown to have meaningful relationships with foreign exchange
rates."
"But those relationships have not proven consistent - over time,"
the analysts concluded.
The analysts did say, however, that most market participants did
have an underlying template for currency performance; one that rewarded
a country with high returns on assets with a stronger currency.
The conundrum with this method is deciding whether the returns
should be defined according to yield or according to capital gains.
The analysts said, "In the real world of the market, the answer to
that question can change as rapidly as market conditions and can even
define "return" by the avoidance of loss.
For now, the U.S. dollar continues to be rewarded for whatever the
reason, as a safe-haven currency or as the currency of a prime
investment target, and there is little on the horizon the change that.
Still many analysts, when seeing the Trade weighted dollar index at
a 16 year high, wonder how much longer this can continue.
"Despite the emergence of the U.S. dollar as the FX market's
favorite through think and thin, there are plausible circumstances
during which the dollar may fall out of favor," said analysts at
Citigroup in a recent report.
"The main risk would be a shock to the U.S., that clearly has no
possibility of being matched elsewhere.
As an example, analysts point to a situation where U.S. households
become sufficiently concerned about the weight of equities in their
portfolio to simultaneously try and raise savings rates and sell
equities.
"The magnitude of the potential adjustment is well beyond what can
be expected elsewhere," they said.
Rather than waiting for the dollar "bubble" to pop, there is some
talk the U.S. may be open to orchestrating a gradual decline in the
dollar.
In Thursday's Wall Street Journal, reporter David Wessel, although
stating that the strong dollar has advantages, especially for a country
like the U.S. that depends heavily on foreign monies, focussed on the
risks of a strong dollar as well.
Wessell said that a strong dollar crimped exports, which was "fine
when the U.S. was booming, but ... no longer convenient."
The second risk, he said, was that the dollar's rise may be
blunting the impact of Fed interest rate cuts.
Lower rates usually work by meaning loans cheaper, by boosting
stock prices and by weakening the dollar.
Wessell also pointed out, like many analysts of late, that "the
dollar is looking suspiciously like the NASDAQ composite Index did a
year ago-something that rises so far so fast that the only issue is when
it will come down and how fast."
Paul Krugman also dealt with this issue in a recent New York Times
editorial.
"One of these days dollar holders may do a Wylie E. Coyote: they
will look down, realize that the currency has nothing to support it, and
down it will plunge."
The U.S. is well aware of the dangers of a downward spiraling
currency, hence reported comments Thursday afternoon by U.S Treasury
Secretary Paul O'Neill stating the "Bush Administration has a strong
dollar policy".
One U.S. portfolio manager agrees that trying to micro-manage the
U.S. dollar is like walking "on a knife edge."
He said that as long as the world was favoring countries with
positive fiscal balances as opposed to trade balances, it was unlikely
that there would be any major change in the dollar.
The next major discussion about the strength of the dollar should
come at the April 28th G-7 meeting in Washington D.C.
David Gilmore, an economist and partner at FX analytics in Essex
CT., said "With the U.S. economy floundering and the current account
deficit growing at an arguably unsustainable pace, G7 officials are
likely to discuss what constitutes a 'too strong dollar.'"
"One can imagine the G7 adopting a communique that goes beyond the
normal language; 'exchange rates among major currencies should reflect
economic fundamentals', even in no specific mention of the yen, euro or
dollar is included."
From the traders viewpoint, there is little in the short term that
would signify any pending change in sentiment out of the dollar.
Fed Chairman Alan Greenspan's adroit management of the economic
slowdown has most market participants, shunning Euroland and Japan -
still willing to bet that the U.S. is still the place to be.
Until something happens to change their mind, the dollar will still
be king.
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