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THE SKEPTIC: ‘Tis The Season To Buy Dollars January 10, 2007

Posted by notapundit in Economic News.
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By Martin Fluck
A DOW JONES NEWSWIRES COLUMN

LONDON (Dow Jones)–The dollar may be about to rebound against the euro even if sizable U.S. housing inventories leave some doubt over how mild the slowdown in the U.S. economy will prove in 2007.

The rebound could happen soon if the high level of net speculative short dollar positions, built up in the latter part of 2006, are reversed now that the dollar’s seasonal winter has passed.

Extremes in net speculative positions are a pretty good a signal to take a contrarian view.

In addition, the repatriation of dollar funds out non-U.S. multinationals toward the end of the fiscal year is typically reversed in the first quarter, making January a strong month for the dollar for the past 15 years.

For the chartists, with the dollar having started the year strongly, the euro looks precariously placed in this context. A move through $1.2970 might see the single currency test $1.2480.

Fundamentally, analysts at banks such as Morgan Stanley and Credit Suisse reckon the dollar is cheap because it’s trading so far below its purchasing power parity, put at $1.06 against the euro.

Strong nominal and real interest-rate differentials also support the dollar – only countries like Australia, New Zealand and Iceland have higher interest rates that the U.S. – and these differentials are likely to be maintained.

That goes for euro zone too.

The ECB may be more likely to raise rates than the U.S., but investors were pricing in a U.S. slowdown for some time only to change their view now that the Federal Reserve has signaled rate cuts are less likely in the context of a strong U.S. jobs market and inflation worries. Last month, investors were was expecting 3 rate cuts from the Federal Reserve in the months ahead, but it is now only expecting one.

The euro-dollar exchange rate could also be supported by a liquidation of emerging market investments, the likelihood of which is growing as some commodity prices decline and as Thailand’s military coup and capital controls remind investors of the risks they can ill afford to ignore in some developing economies.

Currencies and stock markets with commodity exposure like South Africa and Canada have already fallen victim to some New Year selling.

So safe-haven flows into dollar-denominated assets might be another reason why the dollar’s weakness at the end of the 2006 could look like little more than a wobble.

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