By Matthew Brown
While Fed funds futures show the Federal Reserve may raise interest rates as soon as August, the Bank of Japan is likely to keep borrowing costs near zero percent through 2011 as deflation persists, according to the median estimate of economists surveyed by Bloomberg. Betting the dollar will appreciate versus the yen is the top 2010 recommendation at UBS AG, the second- largest foreign-exchange trader.
For the first time since before credit markets began to seize up in 2007, investors are starting to favor selling the yen instead of the dollar to fund higher-yielding investments. The European Central Bank, grappling with debt crises in Greece, Spain and Ireland, may wait until at least October before increasing borrowing costs, a separate survey shows.
“We like buying the dollar in 2010 and that’s quite a change in view,” said Adarsh Sinha, a foreign-exchange strategist at Barclays Capital in London. “We are looking for the very loose monetary conditions in the U.S. to end. The dollar will start firming up well ahead of any rate hike.”
After falling 7.9 percent in the first 11 months of 2009, the Dollar Index, which measures the greenback’s performance against the euro, yen, pound, Canadian dollar, Swiss franc and Swedish krona, gained 4 percent in December. That’s the first monthly gain since June, and the biggest since it rose 5.8 percent in January.
Currency Forecasts
The dollar will strengthen to $1.40 per euro in 2010, from $1.4319 today, and to 100 yen, from 92.78, according to Barclays. An investor selling 12-month yen-denominated bills and buying equivalent-maturity Treasury bills and holding to maturity will earn 7.8 percent if the dollar hits Barclays’ yen target.
The U.S. currency will advance 2.3 percent against the euro in 2010, according to Frankfurt-based Deutsche Bank AG, the world’s largest foreign-exchange trader.
“A relative rise in U.S. rates would be dollar supportive as long as it is materializing in an environment of reasonably robust growth,” said Henrik Gullberg, a currency strategist at Deutsche Bank in London.
U.S. gross domestic product will expand 2.6 percent this year, better than the 1.2 percent for the 16 euro-member nations and 1.35 percent for Japan, according to the median estimate of economists surveyed by Bloomberg. The Fed’s target rate of zero to 0.25 percent compares with 1 percent for the ECB and 0.1 percent for the Bank of Japan.
Reversing Bets
Slower growth outside the U.S. is turning dollar bears into bulls at a pace not seen since the third quarter of 2008, according to data from the Commodity Futures Trading Commission in Washington.
Wagers by hedge funds and other large speculators that the currency will fall against the euro, yen, pound, Swiss franc, Canadian, New Zealand and Australian dollars, and the Mexican peso outnumbered bullish bets by 93,387 contracts on Dec. 22. The difference was 280,855 on Dec. 1.
That’s the fastest reversal since so-called net shorts of 241,216 on July 21, 2008, turned into a net long position of 73,049 four weeks later. The Dollar Index rallied 23 percent between July 15 and Nov. 21 that year.
The dollar’s December gain was a “relief bounce,” according to Gareth Fielding, who manages $2.2 billion as chief investment officer at Quantum Global Wealth Management in Zurich.
Dollar Reserves
That doesn’t change the fact that the U.S. is playing a smaller role in the global economy where growth is being led by China. Ultimately, that’ll mean diminishing demand for dollars, he said.
“Fundamentally, things haven’t changed,” Fielding said. “The dollar’s pre-eminent role in the global economy will diminish. Central banks are likely to continue to diversify away from the U.S. dollar.”
The dollar’s share of global currency reserves fell in the third quarter to the lowest level in a decade while the euro’s rose to a record, according to International Monetary Fund data released on Dec. 30. The U.S. currency’s portion dropped to 61.6 percent in the period ended Sept. 30, from 62.8 percent in the prior quarter and 64.5 percent a year earlier. The euro’s share rose to 27.7 percent from 27.4 percent.
Dollar Weakness
Record debt sales by the U.S. to fund a $1.4 trillion budget deficit may restrain the dollar, after Congress raised the limit on federal borrowing to $12.39 trillion. Also, the currency may remain relatively weak against the currencies of nations whose economies depend on commodities, such as Australia, New Zealand and emerging markets, according to surveys of strategists by Bloomberg News.
The Australian dollar, after surging 27 percent in 2009, may rise as much as another 5.5 percent this year, forecasts show. Korea’s won will gain 7 percent, after strengthening 8.2 percent last year.
“Higher-octane currencies, like the Aussie, the kiwi and the emerging-market currencies such as the won, might perform the best, followed by the dollar, and lagging the whole bunch will be the euro and the yen,” said Stephen Jen, a money manager at BlueGold Capital Management LLP in London and the former head of foreign exchange at Morgan Stanley.
Signs of an improving U.S. economy are pushing up interest rates, making some dollar assets more attractive than those priced in the euro or the yen.
Rate Outlook
The premium investors demand to own 10-year U.S. Treasuries against equivalent-maturity Japanese government bonds rose to 2.58 percentage points today, the most since December 2007. U.S. 10-year yields were 0.49 percentage point more than German bunds on Dec. 22, the biggest gap since July 2007.
The Fed will increase its target rate for overnight loans between banks as much as 0.75 percentage point by the end of the year, according to the median of 68 forecasts compiled by Bloomberg. The ECB will raise its main rate by half a percentage point, based on the median of 16 forecasts, and the BOJ will leave its target unchanged, according to 21 predictions.
As U.S. rates rise, the yen may regain its role as the pre- eminent currency for carry trades, taking over from the dollar.
The cost of borrowing dollars for three months between banks in London fell below the equivalent yen rate for the first time in 16 years in August. The three-month London interbank offered rate, or Libor, for such loans in dollars was 2.69 basis points lower than yen Libor on Dec. 31, compared with 7.25 basis points on Sept. 8. A basis point is 0.01 percentage point.
Japanese Deflation
“We see an intensification of the long-term carry trade where Japanese investors send money abroad,” said Geoffrey Yu, a foreign-exchange strategist at UBS in London. “They’ll get even more interested in sending money overseas as the BOJ keep rates low.”
Japanese consumer prices have fallen on an annual basis since February. BOJ Governor Masaaki Shirakawa told TV Tokyo on Dec. 21 that the central bank will “persistently” keep rates at “virtually zero” to fight deflation.
UBS expects the dollar will appreciate above 100 yen this year, compared with the median estimate of 98 in a survey of 38 strategists and economists. Strategists are struggling to keep up with the currency’s gain versus the euro. A separate survey shows they expect it to rise every quarter this year, to $1.45 by year-end from $1.51 in the first three months.
‘Catch-22’
In Europe, Greece’s credit was downgraded last month by Standard & Poor’s and Fitch Ratings after the government failed to sufficiently address its growing fiscal deficit in its 2010 budget. The outlook on Spain’s AA+ rating was lowered to “negative” by S&P as it predicted the debt burden will rise to as much as 90 percent of GDP by the middle of this decade.
German Chancellor Angela Merkel said on Dec. 10 Europe has a “responsibility” to help Greece. A day later, ECB President Jean-Claude Trichet said the country must take “courageous action” on its own.
“The euro-zone is in a Catch-22,” said Yu. “If they bail out the weak countries you rip apart the stability pact and introduce a huge moral hazard. If you don’t, you risk destabilization. It’s a significant risk for the euro and I don’t think there’s a plan.”
Dollar bulls are encouraged by trading that shows the currency has started to rally in response to better-than- forecast economic news. For much of the past two years, the greenback weakened on signs of a recovery, which encouraged traders to borrow in dollars and use the proceeds to buy riskier assets outside the nation.
Withdrawing Reserves
The Dollar Index surged to a three-month high on Dec. 22 after an industry report showed sales of existing homes rose in November more than economists estimated.
The Fed is taking steps to begin withdrawing money from the financial system. Policy makers will end most emergency lending programs and debt purchases by March because of “improvements in the functioning of financial markets” and stabilizing labor markets, the Federal Open Market Committee said on Dec. 16.
“In the U.S., the political incentive is to keep the fiscal stimulus going, pressuring the Fed to tighten early,” said Jen, who sees the dollar strengthening to $1.35 per euro this year. “The political incentive in Europe is to start to tighten on the fiscal front as fast as possible, putting pressure on the ECB to keep policy loose. That’s more constructive for the dollar than the euro.”
To contact the reporter on this story: Matthew Brown in London at mbrown42@bloomberg.net
Last Updated: January 4, 2010 03:34 EST
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