Outlook For the U.S. Dollar Darkens


Outlook For the U.S. Dollar Darkens

Heading abroad from the U.S. this summer? Consider packing a few extra
dollars. Since early March, the greenback has fallen 11% against the euro
and 17% against Britain’s pound, as investors who had sought out the dollar as a safe haven during the worst of the crisis now head for riskier assets. Throw in concerns over the U.S.’s spiraling deficit
and calls from China for an alternative reserve currency, and “the
likelihood is the dollar’s going to remain under pressure,” says Simon
Derrick, head of currency research at Bank of New York Mellon in London.
“You’re going to see it continue to slide.”

That’s a reversal from the recent uptick. Traditionally a safe bet amid economic mayhem, the
dollar climbed about 25% against the euro in the eight months to March this
year; the unattractiveness of rival currencies only made it more appealing.
But, says, Derrick, “that drive seems to be shifting substantially.” Sure, a
hint of bleak economic data can still goose the greenback — the prospect of
poor U.S. payroll figures for June, set for release Thursday, has helped
boost the currency in recent days — but optimism in other assets is on the
rise. Global equity markets, in particular those in emerging market
countries, have performed well in recent months. China’s Shanghai composite
index, for instance, has shot up 63% so far this year.
Also weighing on the dollar: investor concerns that to balance a budget
deficit expected to swell this fiscal year to $1.85 trillion — equal to 13%
of the country’s GDP, a level not seen since World War II — the Federal
Reserve could simply resort to printing more money, further flooding the
markets with dollars. While the central bank said June 24 it had no plans to
expand its purchase of government or mortgage bonds beyond the $1.2 trillion
earmarked for the purpose in March, not everyone is convinced. “There is
always the nagging concern that if this is just a dead cat bounce in the
equity markets and we have a further rocky ride in the second half of this
year,” says Derrick, “then a second round of fiscal spending programs may
have to be introduced.”
Bottom line: the dollar faces a longer-term challenge, and the big players
know it. Echoing a call made by Zhou Xiaochuan, its governor, in March,
China’s central bank advocated a new global reserve currency in its annual
financial stability report released last Friday. Raising concerns of a move
away from the dollar as the world’s reserve, the proposal for a
“super-sovereign” coin nudged down the greenback versus a host of major
currencies. That may have been a tad more impact that Zhou was seeking: With
something like two-thirds of its roughly $2 trillion of foreign currency
reserves held in dollars, the lower a buck goes, the less China’s vast pot
of cash is worth.
In reality, with 64% of the world’s reserves held in dollars at the end of
last year — way more than in any other money — a move to a new reserve
currency would be both time consuming and complicated. And with China
holding so many dollars, selling even a small amount of its reserves would
dent the value of those that remained. But despite the glitches, argument
over the need for a new international reserve does little to lift sentiment in the dollar’s
favor. Its replacement might be “an implausible suggestion”, analysts at
HSBC wrote in a May note to clients, but “its preeminent position as the
reserves currency of the world does not mean that [the dollar] will
maintain its value.” Like Derrick, HSBC is counting on a further fall in the
months ahead. Better not leave that holiday too late.
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