Dollar to Disappoint as Yield Advantage Lacking, Goldman Says

The dollar will disappoint analysts expecting a broad rally in the currency versus major peers as a tapering of Federal Reserve stimulus isn’t improving the U.S.’s interest-rate advantage, according to Goldman Sachs Group Inc.

The greenback will probably weaken against the euro and the pound over the next six months as investment flows into those economies remain strong in the face of improving U.S. growth prospects, said Thomas Stolper, chief currency strategist at Goldman, in a Feb. 7 interview in Sydney. It will remain “range bound” versus the yen, he said. Strategists surveyed by Bloomberg expect the dollar to climb at least 4 percent against Europe’s common currency and the yen by June 30, while gaining 1.3 percent versus the pound, according to the medians of the estimates compiled.

“Our overall view for the dollar is pretty balanced, but that’s still an out-of-consensus call because people in the market are very focused on tapering and the impact this may have,” Stolper said. “We are quite focused on the transmission channels into FX, but these seem choked at the moment and, as a result, people are continuously disappointed relative to their expectations on the dollar.”

Capital flows into the U.K. and euro area are overwhelming any differences in monetary policy and will spur the European currencies higher, Stolper said. Significant gains versus the yen won’t come until the Fed moves toward raising the benchmark interest rate, he said. Goldman expects the dollar to rise versus its Australian and Canadian counterparts. The Bloomberg Dollar Spot Index, which monitors the greenback against 10 peers, dropped last week after data showed employers added fewer jobs than forecast.

Rising Forecasts

The euro was at $1.3625 as of 1:36 p.m. in Tokyo and is expected to fall to $1.31 by June 30. Analysts in 2013 lifted their median forecast for where the currency would end the year from as low as $1.26 to as high as $1.34 with it trading at $1.3743 on Dec. 31. The pound bought $1.6412 and is predicted to decline to $1.62 in the second quarter. Analysts upgraded estimates for where the currency will trade by the middle of this year every month starting in August.

The yen traded at 102.42 per dollar and will fall to 107 by June 30, according to the analyst median.

Treasuries rose this year, driving down yields, as a mixed picture of the U.S. economy emerged even with the Fed cutting its bond purchase program to $65 billion a month from $85 billion. Data this month has shown American factories expanded at the weakest pace in eight months in January while jobs growth was slower than forecast and the unemployment rate fell to the lowest level since October 2008.

Allocation Shift

Traders see about a 7 percent chance that the Fed will raise the benchmark rate this year from its current range of between zero and 0.25 percent, according to data on futures compiled by Bloomberg. The gap between two-year U.S. yields and those in Germany, the U.K. and Japan is about 20 basis points. The spread to Japanese securities averaged 164 basis points over the past 10 years.

“There’s not much happening on the rates differential front for the dollar and on the growth story, it’s not that international investors have suddenly discovered the U.S.,” said Stolper. “The reality is that everybody has U.S. investments already so the need for an asset allocation shift is not there.”

Growth in the world’s largest economy will probably accelerate to 2.8 percent this year from 1.9 percent in 2013, according to the median of analyst forecasts compiled by Bloomberg. The U.K.’s economy will expand 2.6 percent from 1.9 percent and the euro area’s will grow 1 percent following last year’s 0.4 percent contraction, the estimates show.

Basic Carry

“Against the European currencies, generally the dollar is going to weaken slightly,” said Stolper. “Sterling even more so than the euro because the growth acceleration in the U.K. has been more pronounced, likely boosting capital flows into sterling, at least for now.”

Over six months, the pound will climb to $1.69 and the euro will advance to $1.40, according to Goldman. The dollar will trade in a range of 95 to 105 yen, Stolper said separately in a conference in Sydney.

For the dollar to rise to 120 yen or further the Fed needs to get closer to raising rates, which may be something the market begins to anticipate in the middle of next year, he said.

“It’s not a story for 2014,” he said. “The key to that is front-end rate differentials, so you need very basic carry to come back.”

Carry is often used to refer to trades where the interest return exceeds the cost of the funds used to make the investment.

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