There’s at least one thing that bulls and bears on the U.S. economy agree on: the dollar, the most undervalued major currency in the world, is due to rise as Europe’s sovereign debt crisis threatens the global recovery.
Strategists who as recently as November were predicting the dollar would depreciate against currencies of the Group of 10 nations, now say it will climb by year-end. After weakening against all but the Mexican peso among its 16 most actively traded peers over the past decade, it has gained against 13 of them since February.
Bulls say the dollar will benefit from increased U.S. hiring and an economy that’s projected to grow 2.3 percent this year, almost double the 1.26 percent for the Group of 10, according to Bloomberg surveys of economists. The currency will also gain if global and U.S. growth slows as Europe’s debt crisis worsens, boosting demand for dollar assets such as Treasuries as traditional havens from market turmoil diminish.
“We’ve become more bullish on the dollar because the economic prospects in the U.S. are improving,” Ken Dickson, an investment director of currencies at Standard Life Investments in Edinburgh, which manages about $235 billion, said on April 18 by telephone. “There are additional reasons including problems in the periphery, and a weaker euro is required to help the transition to a better economic situation in Europe.”
Scotland’s second-biggest money manager is “overweight” the dollar against the yen and the euro, meaning it owns a greater percentage denominated in the currency than is contained in benchmark indexes. The greenback may climb about 9 percent to $1.20 per euro in the next six months, Dickson said.
Currency analysts predict it will appreciate 1 percent versus other G-10 currencies by the end of this year, according to the average median estimates of strategists surveyed by Bloomberg, from a 4 percent drop expected in November.
It strengthened 0.7 percent to 81.52 yen last week and fell 1.1 percent to $1.3219 per euro. The dollar slid 0.5 percent to 81.10 yen as of 2:12 p.m. New York time, and appreciated 0.6 percent to $1.3136 per euro.
Currency strategists expect the dollar to advance to $1.30 per euro and 84 yen by year-end, based on the median estimate of at least 46 analysts compiled by Bloomberg. That compares with November estimates of $1.41 per euro and 80 yen.
Demand is being buoyed as central banks in Japan and Switzerland resist gains in their currencies, with both nations seeking to protect their exporters from rising prices for their goods. That leaves the dollar as the sole haven for investors seeking refuge from Europe’s crisis.
Japan has intervened to curb the yen’s 60 percent appreciation over the past decade. The currency surged to a post-World War II record of 75.35 per dollar in October before slipping about 8 percent. The Swiss National Bank imposed a 1.20 franc per euro ceiling on Sept. 6, and the franc has fallen 0.3 percent versus the dollar since the end of that month.
Global gross domestic product will expand 3.5 percent this year and 4.1 percent in 2013, the International Monetary Fund said last week in its World Economic Outlook, raising forecasts made in January from 3.3 percent for 2012 and 4 percent for next year. The U.S. will grow 2.1 percent this year and the euro area is projected to decline by 0.3 percent in 2012.
The euro zone’s $12.1 trillion economy is the world’s second-largest, after the U.S.’s $14.6 trillion, according to data compiled by Bloomberg.
There’s a risk of the euro sliding to $1.25 “if sovereign funding conditions deteriorate significantly,” John Normand, the London-based head of currency strategy at JPMorgan Chase & Co., said April 19. “Our view is that the funding stress, although intense sometimes, is manageable” and the euro may rebound to $1.34 this quarter, he said in an interview.
While the dollar has benefited from its role as the world’s reserve currency, with 62 percent of global holdings, its value fell in foreign-exchange markets as the Federal Reserve printed $2.3 trillion to inject into the economy after the financial crisis began five years ago.
IntercontinentalExchange Inc.’s Dollar Index, which tracks the currency against those of six trading partners, tumbled 14 percent during the Fed’s two rounds of asset purchases, known as quantitative easing, or QE, between December 2008 and June 2011.
Strategists who expect the dollar to decline say that while the U.S. unemployment rate is at the lowest in three years, payrolls increased by the least in five months in March and the Fed may introduce more QE before year-end.
More Americans than forecast filed applications for unemployment benefits in the week through April 14, a government report showed on April 19, adding to signs the improvement in labor-market conditions may be faltering.
Fed Chairman Ben S. Bernanke said last month that further “significant” improvements in employment would probably require a more-rapid expansion.
“Prospects of QE3 had never left the table,” said Michael Woolfolk, senior currency strategist in New York at Bank of New York Mellon Corp., the world’s largest custodial bank, with more than $26 trillion in assets under custody and administration.
Woolfolk expects the dollar to weaken to $1.40 per euro and to appreciate to 90 yen by the end of the year.
“QE3 would send a signal that the Fed wants to continue to grow the balance sheet and continue with the foot on the accelerator in terms of monetary policy,” he said. “This would be viewed as negative for the dollar by the market.”
The odds of more easing measures by the Fed are 50 percent or higher, the majority in a Bloomberg News survey of the 21 primary dealers that trade with the Fed showed this month.
Longer-term depreciation has left the dollar as the only G- 10 currency undervalued versus the euro, by 5.6 percent, based on an index by the Organization for Economic Cooperation and Development that uses relative costs of goods and services.
The dollar is too weak by 31 percent against the yen and 24 percent compared with its Canadian counterpart, according to the Paris-based OECD.
“The dollar is probably about 20 percent undervalued,” John Taylor, who manages about $4.5 billion as founder and chief executive officer of New York-based currency hedge fund FX Concepts LLC, said in an April 20 telephone interview. “It will be stronger against the euro and yen and even against the emerging markets.”
Central Bank Steps
Like the Fed, policy makers in Japan and Europe have taken steps to support their economies with fiscal stimulus.
The Bank of Japan is “committed” to monetary easing, Governor Masaaki Shirakawa said April 18 in a speech in New York. The European Central Bank issued about 1 trillion euros ($1.3 trillion) in three-year loans to area banks in two longer- term refinancing operations, or LTROs, in December and February.
New Fed stimulus may be sterilized, which would involve the simultaneous draining of cash from the banking system through the repurchase agreement market. The central bank is now replacing $400 billion in shorter-term holdings with longer-term debt in a program called Operation Twist that expires in June.
“The bias at this point is toward steady monetary policy in the U.S. relative to other central banks that could ease further,” Nick Bennenbroek, head of currency strategy at Wells Fargo & Co. in New York, said in an April 17 telephone interview. “The economy in the U.S. is going to be steady, so when we look at those trends elsewhere, we feel the dollar should benefit overall.”
Dollar Index Rally
Wells Fargo revised its year-end forecast for the dollar against the yen to 84 last week, after predicting 80 yen at the beginning of the year. It expects the greenback to end the year at $1.24 per euro.
The Dollar Index (DXY) has rallied more than 2 percent since the Fed announced the start of Operation Twist on Sept. 21. Indicators such as retail sales, manufacturing and consumer confidence signal a pickup in the recovery.
Consumer sentiment has been above 70 every month this year, according to the Thomson Reuters/University of Michigan index. The gauge averaged 64.2 during the last recession and 89 in the five years before the crisis. Retail sales rose 0.8 percent in March, exceeding the 0.3 percent median estimate of 81 economists surveyed by Bloomberg, Commerce Department data last week showed.
The ISM index of manufacturing activity jumped to 53.4 last month, from a two-year low of 51.4 reached in July. It is down from a high of 59.9 in January 2011.
Bets on dollar gains are growing as Europe’s debt crisis, which started in Greece in October 2009, persists. Italy last week delayed its goal to balance the budget by one year to 2014, joining Spain in missing fiscal targets amid a worsening recession.
Hedge funds and other large speculators increased bets the dollar will rise against the euro to 118,125 contracts in the week ended April 17 from 101,364 the previous week, according to Commodity Futures Trading Commission data. Against the yen, futures traders are long the dollar by 57,803 contracts.
“We expect the U.S. economy to outperform a lot of Europe, therefore we look for the dollar to appreciate over the course of this year,” Sara Yates, a foreign-exchange strategist at Barclays Plc in London, who sees the dollar climbing to $1.25 in six months and $1.20 in a year, said in an interview on April 17. “It’s also the case that if we get euro-area risk really coming back to the fore, then the dollar will do well.”