Traders, strategists expect central banks to prop dollar

Section:

They'll intervene in all markets except the precious metals markets, right?

* * *

Expect Global Support for U.S. Dollar

From Bloomberg News
via The Age, Melbourne, Australia
Monday, September 29, 2008

http://business.theage.com.au/business/expect-global-support-for-us-doll...

A growing number of currency traders and strategists are starting to speculate that finance ministers from the world's biggest economies will join to support the US dollar.

Volatility in currencies is the highest since 2000, when the so-called Group of Seven nations last intervened in the foreign-exchange market. The dollar weakened 2.5% on a trade-weighted basis in the past two weeks as the turmoil on Wall Street intensified. It had the biggest one-day drop against the euro since 2001 a week ago.

While the US dollar strengthened 9% from its record low against the euro on July 15, wider price swings threaten to undermine confidence in the US currency just as government borrowing rises and Treasury Secretary Henry Paulson prepares a plan to bail out of the nation's banks. The greenback is still down 23% since 2005.

"We're getting closer to the right conditions for authorities to step in and prop up the dollar," said Maxime Tessier, who manages $US151 billion as head of foreign exchange in Montreal at Caisse de Depot et Placement. "The nightmare scenario will be a wholesale loss of confidence in the dollar."

The US dollar weakened 2.7% to $US1.4614 per euro last week from $US1.4224 on Sept. 12. The broader US Dollar Index fell to 76.953 from 78.966. The Australian dollar was recently trading at 82.8 US cents.

Even a hint that finance ministers may influence exchange rates may be enough to set a floor under the currency after efforts by the Federal Reserve, European Central Bank, and Bank of Japan failed to revive investor confidence by injecting more than $US1 trillion ($1.2 trillion) into the world financial system.

... 'Extraordinary interventions'

"The central banks of the world have embarked on all sorts of extraordinary interventions," said Stephen Jen, the global head of currency research at Morgan Stanley in London. "Currency joint intervention would be the least surprising. And it would probably be the cheapest."

Morgan Stanley's intervention watch index suggests an 18% chance that policy makers will step into the market to influence exchange rates. Any reading above 10% suggests the risk is "meaningful," or elevated, according to the New York-based firm.

The index, based on interest rates, trading patterns and investor positions, is accurate 78% of the time. The index is at the same level as when the G-7 intervened in 2000.

Finance ministers from the G-7 are more concerned about rapid swings in exchange rates than the absolute level of currencies because volatility complicates the assessment of economies, interferes with monetary policy, and gives companies little time to adjust by cutting costs.

... 'Sharp fluctuations'

Sadia SA, Brazil's second-biggest food company, posted a 760 million-real ($494 million) loss last week related to foreign-exchange hedges after the nation's currency tumbled 26% from a nine-year high on Aug. 1.

The G-7, which includes the US, Japan, Germany, Britain, France, Italy, and Canada, warned in April against the implications of "sharp fluctuations in major currencies," the first time since 2004 than the group used such language. Shoichi Nakagawa, Japan's new finance minister, reiterated that view on Sept. 26, saying "sharp fluctuations in the foreign exchange market aren't good."

Implied volatility on one-month euro-dollar options rose to an eight-year high of 15.55% on Sept. 18, the same level that triggered the G-7 to buy euros in 2000 to halt the 27% slide from its 1999 debut. Volatility ended at 14.51% last week, up from this year's low of 8.02% on Aug. 1.

... US growth

Weakness in the dollar hasn't become so disruptive to suggest imminent intervention, said Ken Jakubzak, who manages the KML Currency Program in Chicago for KMJ Capital LLC, which has $US100 million under management.

The currency is 3% stronger than its record low in March on a trade-weighted basis. Some investors say the currency may rally as the economies outside the US slow.

Growth in the euro-zone will decelerate to 1.35% this year from 2.63% in 2007, according the median estimate of economists surveyed by Bloomberg. Japan's economy may expand 1%, compared with 2.08%, while the US economy will likely grow 1.7%, the surveys showed.

The dollar will rally to $US1.43 per euro by year-end and to $US1.40 by the end of first quarter, according to the median estimate of more than 40 economists and strategists surveyed by Bloomberg.

"Should the bailout plan succeed in stabilizing the markets, the sentiment will shift to be more constructive for the dollar," said Jakubzak, who expects the dollar to rise to $US1.30 by year-end. "What happens in the US will also happen in the other places in the world."

... Paulson plan

US lawmakers are reviewing a tentative agreement to revive credit markets by authorizing a $US700 billion plan to buy troubled assets from financial institutions. "The deal is done," said Senator Judd Gregg, a New Hampshire Republican, a ranking member of the Budget Committee. The House and Senate may vote Sept. 29 on it, he said.

Dollar bears say the US budget and trade deficits and negative real interest rates make a sustained dollar rally unlikely. Paulson's plan to buy devalued securities from banks would drive US government debt above 70% of gross domestic product, the most since 1954, based on economist estimates and details of the bailout.

If the Treasury spends the entire amount next year, it would drive next year's budget deficit to $US1 trillion or more from about $US500 billion now. Michael Feroli, an economist at JPMorgan Chase & Co. in New York, estimated the combination of the Paulson plan, additional government expenditures, and a slower economy, may swell the deficit to $US1.5 trillion, or 10% of GDP.

... Barclays, TD

The currency will drop to $US1.57 per euro by year-end, according to London-based Barclays Plc, the world's third largest foreign exhcange trader. Toronto-based TD Securities, a unit of Canada's second-biggest bank by assets, said it will weaken below $US1.60 in the next few months.

"Authorities don't want excessive dollar weakness to feed the sell-America mentality," said Chris Turner, head of foreign exchange strategies in London at ING Groep NV, the largest Dutch financial-services company. "We are not there yet, but the risk is there. People I speak to are worried about a budget explosion."

The government depends on foreign money to finance the budget deficit because investors outside the US own 56% of the $US4.8 trillion in marketable Treasuries outstanding, up from 42% five years ago, according to data compiled by the government.

While the G-7 decided against intervening in April when the dollar fell below $US1.60 per euro for the first time, tolerance for a weaker currency may be limited because of the turmoil sweeping the financial system. The next meeting is scheduled for Oct. 10 in Washington.

... 'Been crushed'

In the past month, the government took over Washington- based Fannie Mae and McLean, Virginia-based Freddie Mac, the two biggest mortgage finance companies, as well as New York-based American International Group Inc., the largest US insurer. New York-based Lehman Brothers went bankrupt and Washington Mutual Inc. of Seattle was seized by regulators in the biggest bank failure in US history.

"At the end of the day, the financial sector is our flagship," Kenneth Rogoff, a professor of economics at Harvard University and a former a former chief economist at the International Monetary Fund, said in an interview on Bloomberg Radio Sept. 19. "It has been crushed, and that's going to have a big impact on international capital flows. That's going to affect the positions of the dollar in the global financial system."

* * *

Join GATA here:

Toronto Resource Investment Conference
Saturday-Sunday, October 4-5
Metro Toronto Convention Centre, Toronto, Canada
http://goldshow.ca/ch_tor2008.html

New Orleans Investment Conference
Thursday-Monday, November 13-18, 2008
New Orleans Marriott Hotel
http://www.NewOrleansConference.com

* * *

Help Keep GATA Going

GATA is a civil rights and educational organization based in the United States and tax-exempt under the U.S. Internal Revenue Code. Its e-mail dispatches are free, and you can subscribe at http://www.gata.org/.