Dollar Downgraded as Standard Life Predicts Damage

Washington’s wrangling over a partial government shutdown and lifting the U.S.’s borrowing limit has strategists cutting their forecasts for the dollar for a third straight month, the longest stretch this year.

From Credit Suisse Group AG to Westpac Banking Corp., firms have lowered the median estimate for the U.S. currency versus the euro, pound, Canadian dollar, Swiss franc and Japanese yen by an average 1.2 percent in October, data compiled by Bloomberg show. That follows a 1.7 percent reduction last month, which was the biggest this year, and a 1.2 percent cut in August.

With a lapse in U.S. borrowing authority now just three days away, a deal which averts a default and restores full government operations continues to elude politicians. That may encourage the Federal Reserve to keep printing dollars to inject cash into the financial system by buying bonds.

“The dollar should increasingly trade across the board on the back foot,” Richard Franulovich, the chief currency strategist for the northern hemisphere at Westpac in New York, said in an Oct. 9 phone interview. “If and when the situation is resolved, there will be a relief rally for the dollar, but I don’t expect that rally to have any legs.”

‘Lasting Damage’

The Bloomberg U.S. Dollar Index, which tracks the greenback against 10 counterparts including the euro, yen and pound, is down 4.3 percent from a three-year high in July amid speculation the Fed won’t reduce its bond purchases before year-end. The gauge fell to 1,010.99 as of 1:05 p.m. in New York, from 1,056.33 on July 8, paring its increase this year to 2.5 percent.

The 1.2 percent aggregate reduction across the five currency pairs this month matches the second-biggest cut in forecasts this year, according to data compiled by Bloomberg. In April, firms surveyed raised the median prediction for the dollar against its peers by 2.2 percent.

Repeated episodes of government dysfunction are eroding faith in the U.S. currency, according to Andrew Milligan, the Edinburgh-based head of global strategy at Standard Life Investments Ltd., which oversees about $271 billion.

“Lasting damage is being caused to the view that the U.S. currency is the reserve currency,” Milligan said Oct. 9 in New York. “It encourages people not to hold so much in dollars and to hold slightly more in other currencies.”

No Deal

Democratic lawmakers warned that the lack of a deal this weekend to avoid breaching the U.S.’s $16.7 trillion debt ceiling on Oct. 17 may have an effect on financial markets today. The yen, viewed by investors as a haven, gained 0.2 percent to 98.37 per dollar, data compiled by Bloomberg show.

International Monetary Fund Managing Director Christine Lagarde said in an interview with NBC’S “Meet the Press” yesterday that congressional deadlock is threatening the $15.7 trillion U.S. economy as well as the rest of the world.

Republican lawmakers have sought to use the crisis to repeal or delay President Barack Obama’s 2010 health-care law. The political debacle is weighing on a dollar already under pressure from the Fed’s unprecedented monetary easing, which involves purchasing $85 billion of bonds a month.

Fed Chairman Ben S. Bernanke surprised markets, and weakened the currency, when he said Sept. 18 that the central bank wouldn’t taper stimulus measures until it saw a more sustained improvement in the economy.

Policy makers are seeking to drive down an unemployment rate that peaked at 10 percent four years ago and which hasn’t been less than 7 percent since November 2008. The rate fell to 7.3 percent in August, from 7.4 percent the month before, the Labor Department said Sept. 6.

‘Confidence Shock’

“There’s a negative confidence shock rippling through the economy, and foreign investors have taken fright at developments in Washington,” said Westpac’s Franulovich. “Tapering is going to last longer. There’s some longer-term ramifications the dollar’s got to deal with as well, all of which are negative.”

The dollar has weakened 3.5 percent against a basket of nine developed-market peers in the past three months, the biggest decline in the group followed by the Canadian currency’s 3 percent drop, Bloomberg Correlation-Weighted Indexes show.

While strategists are lowering their outlook, they still expect the dollar to strengthen or remain little changed versus its five major peers for the rest of this year.

The euro will decline to $1.32 by Dec. 31, from $1.3575, according to the median estimate in a Bloomberg survey of about 80 analysts. They predicted a year-end level of $1.28 on Sept. 16. Westpac increased its euro forecast to $1.36 as of Oct. 4 from $1.31 on Sept. 9, while Credit Suisse’s outlook was $1.40 on Oct. 9, from $1.30 on Sept. 26.

Buying Opportunity

Washington’s stalemate may create an opportunity to buy the dollar because other major currencies “have been overshooting” the greenback for about three weeks, John Normand, the head of foreign-exchange and international rates strategy at JPMorgan Chase & Co. in London, said in an Oct. 9 note.

The franc, pound and euro are about 3 percent, 2.8 percent and 1.5 percent overvalued relative to levels based on bond yields, interest rates and equity volatility, Normand said.

More Bearish

Should the budget deadlock be resolved, the dollar “belongs” at about $1.33 versus the euro, $1.55 per pound and at 0.94 Swiss francs, he said. The franc was at 0.9101 today.

Futures traders are becoming more bearish on the dollar, increasing bets that the euro will advance against the U.S. currency to the most since May 2011, according to Sept. 24 data from the Commodity Futures Trading Commission.

The difference in the number of wagers by hedge funds and other large speculators on a gain in the euro compared with those on a drop -- so-called net longs -- was 65,844, compared with 31,907 a week earlier, the Washington-based CFTC said. The figures haven’t been updated since the government shutdown.

“We had forecast a strong dollar recovery in the final quarter of the year and some of that was related to the anticipated launch of the Fed’s shift in policy,” Nick Bennenbroek, the head of currency strategy at Wells Fargo & Co. in New York, said in an Oct. 9 phone interview, estimating the euro will end the year at $1.35. “With recent events, we see the dollar’s recovery a little bit later, and maybe even a little bit more limited.”

Before it's here, it's on the Bloomberg Terminal.