The sky is STILL falling :) On 1/5/06, Gruss Gott wrote: > > Deanna wrote: > > Ha! Like there's enough to share. > > > > Here's some more Cassandra dollar analysis. Once again, I now own > Euros which I traded for a loss to Yen last year. Let's see if I'll > lose again this year: > > The greenback's sinking feeling > Jan 5th 2006 > From The Economist print edition > > The American currency made a weak start to the year, suffering its > biggest two-day drop against the euro in two years. Its slide could be > unexpectedly steep > > FOR Bill Gates, Warren Buffett and many Wall Street number-crunchers, > the dollar supplied one of the nastiest surprises of 2005. The world's > two richest men and most financial-market seers predicted that the > greenback would fall last year, dragged down by America's colossal > current-account deficit. Many forecasters were predicting that the > euro would buy $1.40-odd by now and that a dollar would fetch less > than ¥100. > > They were all wrong. Although America's current-account deficit headed > towards $800 billion in 2005, the dollar rose. It was up by 3.5% > against a broad trade-weighted basket of currencies, the first rise in > four years (see chart). Against the euro and yen, the greenback did > even better. It ended the year at $1.18 per euro, up by 14%. Despite a > wobble in December, the dollar made a similar advance against the yen. > > Not surprisingly, the pundits are more cautious about 2006. Although > most expect the dollar to end this year weaker than it began it, the > typical forecast is that any decline will be fairly modest and take > place mainly in the latter part of 2006. That is because most analysts > attribute the dollar's recent strength to widening differences between > American, European and Japanese interest rates. These gaps are > expected to grow for a few more months before closing slightly later > in the year. > > The Federal Reserve raised short-term interest rates eight times in > 2005, to 4.25%. Japan, in contrast, kept the liquidity taps open and > interest rates at zero, while the European Central Bank raised rates > only once, in December, to 2.25%. Relatively higher American interest > rates brought foreign capital pouring into dollar assets and pushed > the currency up. > > By this logic, as long as America raises rates faster than others, the > dollar will stay strong. But as America's tightening campaign levels > off and European or (maybe) Japanese rates rise, the dollar will > weaken. The consensus, according to a recent compilation of forecasts > by the Reuters news agency, suggests that the dollar could reach $1.25 > per euro and ¥108 by the end of the year. > > Judged by the first few days of 2006, those forecasts may prove too > sanguine. The dollar suffered its biggest two-day drop against the > euro in two years, and hit a two-month low of $1.21 against the > European currency on Wednesday January 4th; it recovered some of the > lost ground in early trading on Thursday. > > One reason for the dip is that investors are becoming jittery about > how soon the interest-rate gap might stop growing. The dollar swooned > after the release this week of the minutes of the Fed's December > meeting, which suggested that short-term interest rates might not need > to go much higher. > > An interest-rate gap that was merely stable ought to imply a weaker > dollar. According to economic theory, it is the widening of > interest-rate differentials that temporarily strengthens the exchange > rate. Over time, an international difference in interest rates is > offset by a drop in the currency with the higher interest rate. > > Financial markets may also have become too obsessed with the influence > of interest rates on currencies. Historically, interest-rate > differentials have been little more use than anything else at > predicting short-term movements in exchange rates. > > And there are plenty of other reasons to worry about the dollar. One > clear, albeit modest, source of support for the currency in 2005 was > the one-off repatriation of American firms' foreign profits thanks to > a one-year tax break. That is now over. > > Oil exporters may prove more fickle dollar buyers than many expect. In > 2005, as oil prices shot up, exporting countries saw their external > surpluses soar. A good slice of these petrosurpluses found their way > into dollar-denominated assets. That led some analysts to conclude > that oil exporters were a safe and lasting source of dollar support. > An alternative view is that the exporters, like others, were attracted > by rising American interest rates. A recent study by the Bank for > International Settlements, for instance, suggested that the currency > composition of OPEC members' deposits has become more sensitive to > interest-rate differentials. > > China is yet another cause of uncertainty. Its eagerly awaited but > ultimately minuscule exchange-rate shift in July 2005 was a boon for > the dollar because it did not set in train a wider realignment of > Asian currencies. This year the opposite may occur, with the Chinese > allowing a bigger move in the yuan than markets expect. This week > China introduced a system of marketmaking in spot yuan trading that > could permit faster appreciation. > > But the biggest shadow remains America's huge and rising > current-account deficit. Reducing this will, at some point, require a > much cheaper dollar. According to Jim O'Neill of Goldman Sachs, fears > over the current account lurked behind the scenes even in 2005. > According to his models, interest-rate differentials alone suggest the > dollar should be around $1.10 to the euro, or about 10% stronger than > it is. He puts the discount down to nervousness about the current > account. The real risk is that this nervousness takes centre stage > just as the interest-rate gap fades. The result could be a sharp drop > for the dollar. >
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