Dollar rally may fizzle on recovery

Bloomberg

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The dollar, yen and Swiss franc may weaken this year against 2008’s biggest losers in the currency markets as the global economy starts to recover, the largest foreign-exchange strategists and investors say.

The winners will be the Brazilian real, Indonesian rupiah and Polish zloty as investors return to higher-yielding assets, according to surveys. The dollar may strengthen versus the euro and Japanese yen, while dropping against the British pound.

"Our strategy for 2009 is to gradually increase risk," said Maxime Tessier, who manages $151 billion as head of foreign exchange in Montreal at Caisse de Depot et Placement du Quebec, Canada’s largest pension-fund manager. "A year from now, I definitely want to be on the short side on the dollar. We will see capital flows out of the U.S. again."

While the International Monetary Fund cut its 2009 growth forecast for the world economy to 2.2 percent in November, investors are growing more confident as central banks lower interest rates and governments earmark trillions of dollars for fiscal stimulus. The Dollar Index that tracks the currency against six of the U.S.’s biggest trading partners fell 6 percent last month, the most since July 1985, after rising 18 percent from June to the end of November.

Losing steam on rate cuts
The dollar lost steam as the Federal Reserve cut its target rate for overnight loans between banks to as low as zero and poured $8.5 trillion into the financial system. Treasury yields fell to records last year and rates on bills dropped below zero last month for the first time as investors sought safety in government debt.

Faster economic growth will cause the dollar to weaken to 2.30 against the real from 2.3145 at the end of 2008, according to the surveys. The rupiah may follow, gaining 11 percent against the dollar to 9,850 by the end of 2010, while Poland’s zloty strengthens 13 percent to 2.62 in two years, the surveys show.

The pound may strengthen 3.5 percent to $1.51 this year, while the euro will depreciate 8.4 percent to $1.28, strategists said. The yen, last year’s best-performing major currency, may lose 10 percent, they said.

Lawrence Goodman, head of emerging market currency strategy at Bank of America, said countries that prove better at withstanding the crisis should benefit as the flight to safety slows. The dollar will decline 18 percent against the real and 19.5 percent versus the zloty, he said.

"The U.S. dollar will get weaker versus emerging-market currencies," said Mark Mobius, executive chairman of Templeton Asset Management. "The reason why we had this weakness in emerging-market currencies is because of the rush into the U.S. Treasuries, into dollars. I don’t think that’s sustainable."

Flooding the globe
Investors see little need to hold dollar assets as the Fed floods the world with greenbacks, the U.S. budget deficit swells to $1 trillion and with the trade gap exceeding $57 billion. China cut the share of dollars in its $1.9 trillion of reserves to about 45 percent last year from more than 70 percent in 2003, Deutsche Bank in Frankfurt estimates.

U.S. efforts to fix the financial system may still support the dollar by helping the economy recover faster than Europe and Japan.

Deutsche Bank, the world’s biggest currency trader, is among the most bullish on the dollar, forecasting a rally to $1.20 versus the euro, and to $1.30 against the pound, as the European Central Bank cuts its target rate to 0.75 percent this year from 2.5 percent, and the Bank of England lowers its benchmark to 0.5 percent from 2 percent.

Bank of England policy makers meeting Jan. 8 are likely to lower their target rate to 1.5 percent, according to a survey by Bloomberg. The ECB meets Jan. 15 to set borrowing costs.

"Like after the Great Depression, the recession in the 1970s and the end of the Cold War, the U.S. will emerge strengthened from this crisis and our competitors won’t," said Marc Chandler, head of currency strategy at Brown Brothers Harriman & Co. "Our policies have been very aggressive while the rest of the world has been dragging its feet." By year-end, the dollar will trade at $1.30 against the euro, and at 100 yen, Chandler said. He predicts it will trade at $1.42 per pound.

The greenback’s share of foreign reserves rose in the third quarter to 64.6 percent from 63 percent at the end of June, the IMF said Dec. 31, the biggest increase since the first three months of 2004. Investors bought the dollar to purchase Treasuries.