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Dollar May Be Set for Nosedive

The U.S. dollar could be on the brink of a major drop in value as investors and central bank reserve managers start to question their appetite for Treasurys and the greenback's safe-haven status wears off, prominent currency watchers warn.

The euro and even embattled sterling have shot higher against the U.S. currency in recent days despite a lack of meaningfully positive economic news.

Now some heavyweight strategists think the euro could sweep up to 9% higher against the dollar in a matter of weeks, in a move that could prompt a new era of official intervention in the currency markets.

Bilal Hafeez, the global head of currencies research at Deutsche Bank -- the world's biggest foreign-exchange bank by market share -- said he has been expecting a move up to $1.50 for the euro since the beginning of the year. Mr. Hafeez said he reckons the 16-country European currency will hit that point or higher over this summer.

But many are doubtful. "I believe in a weaker dollar environment over the medium term, but $1.50 by the summer is too far, too much, too fast," said Thanos Papasavvas, a currency fund manager at asset manager Investec in London. A sharp move higher for the euro relies on "a lot of ifs," he added.

Straight after Mr. Hafeez released his view, he certainly appeared to be mistaken. The euro plunged from around $1.40 at the start of the year to lows of just under $1.25 in early March.

Concerns over euro-zone banks' exposures to the troubled Eastern Europe region, and the chance that the European Central Bank could cut interest rates further, offer solid reasons not to buy the euro from here, leaving the key euro/dollar currency pair trapped in a range.

"Why hold euros when you can hold the Swedish krona, the Norwegian krone, sterling, the Australian dollar or New Zealand dollar?" said Mr. Papasavvas.

Since then, though, the euro has swept straight back up to $1.38 again. Now, with the currency at the top of the range it has held against the dollar all year, a break higher is looking increasingly plausible. But investors generally aren't prepared for it, Mr. Hafeez said.

"At first, many people did not agree with the direction (of our view)," said Mr. Hafeez. "Now they agree with the direction, but not with the scale of the move. The view is gaining momentum."

Negatives for the dollar have been around for some time. Interest rates -- a key support for currencies -- stand very close to zero. A huge program of central bank asset purchases acts as a further easing tool.

The economy is clearly in a tough spot and is likely to remain under severe stress for longer than many economists had predicted, as the U.S. Federal Reserve reminded markets this week.

Still, the dollar has been relatively robust until recent weeks, in part because of its support from safe-haven flows, as investors park their funds in what is traditionally perceived as a low-risk currency.

Now, though, doubts are emerging over the U.S. bond market. The threat of inflation is undermining its attraction, and there has been a steady dribble of comments and analysis indicating that some of the dollar's biggest supporters -- Asian central banks -- might start to shy away from the greenback.

In addition, it appears that some of the large panic flows into dollars that began with the demise of Lehman Brothers Holdings in October are now starting to reverse. Investors are starting to seek returns in assets that aren't denominated in dollars, boosting risk-sensitive currencies such as the Australian and New Zealand dollars and a range of emerging-markets currencies.

Day-to-day rises in risk aversion are failing to boost the dollar in the way that has become familiar over the past several months.

"The fact that the weakness in U.S. stocks failed to help the dollar in terms of a risk-aversion bid (earlier this week), reveals that dollar bearishness is becoming more entrenched," said Mitul Kotecha, head of global foreign-exchange strategy at French bank Calyon in Hong Kong.

Now, the bearish dollar arguments are carrying more weight. Aside from Deutsche Bank's $1.50 view, Standard Bank is looking for a move to $1.55 within a year. JP Morgan has revised its dollar forecasts lower, predicting $1.45 by December, from its previous expectations of $1.34. Japanese bank Nomura said it thinks the unconventional easing policy in the U.S. will spark a euro surge to $1.50 by the end of the year.

Intervention to pull down the euro and help European exporters would be a possibility at those sorts of levels, said Mr. Hafeez. But he said he doubts it would happen.

"If you look at the euro on a trade-weighted basis, it hasn't gone up that much," he said. "A strong dollar policy could come through if the authorities become really fearful of a buyers' strike in Treasurys, but not before. At this stage, if we go to $1.50, that wouldn't be enough to prompt a strong reaction. The euro would have to hit new highs at $1.60 or so."

SOURCE: http://online.wsj.com/article/SB124291514754643399.html


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