Is Dollar Still Destined to Fall? Yes, Analysts Say Conrad de Aenlle Saturday, October 27, 2001
FOR THE LAST TWO years, people who follow currency movements - economists, money managers, bankers, traders - have been convinced that the dollar was due for a decline against other major currencies, especially the euro. For nearly all of the last two years, those people have been wrong; the dollar has held up against a burst stock market bubble, a (probable) recession, a terrorist attack and anthrax spores.
So now, after marveling at the resilience of what has come to be known as "the Teflon dollar," which currency do professional investors favor? The euro.
Still.
Merrill Lynch Co., in its monthly global poll of fund managers, has found a persistent preference for the euro. In its most recent survey, reflecting opinions in September, 63 percent of fund managers cited the euro as their favored currency, up from 57 percent in August. Their least favored was the yen, whose diminished stature is a result of the never-ending recession in Japan.
The fund managers and analysts interviewed here all anticipated a fall in the dollar, although they differed in their opinions of the extent and imminence of the decline.
Didi Ager, who runs bond portfolios at Gartmore Investment Management Ltd., is an aggressive dollar seller.
"Basically I would expect it to trade lower going forward," she said. "My expectation is we should see it weaken definitely against the euro and Swiss franc." She said that she also expected the euro to rise against the British pound and the pound to rise against the dollar, but she was not as sure about either of those as she was about the euro/dollar rate.
In fact, she seemed the most convinced of anyone interviewed that investors and traders should be in euros and out of the dollar. She recommended that traders of foreign-exchange forward contracts - agreements to buy or sell one currency for another at a fixed future date - bet against the U.S. currency three different ways: go long euro/dollar, short dollar/yen and short dollar/Swiss franc.
Demonstrating her conviction, she added: "These are trades that one would have on now rather than waiting."
Unless one is John Beck, chief investment officer in London for Fiduciary Trust Co. International. Mr. Beck is in no hurry to bet either on the dollar or the euro, or on the yen, for that matter.
"The currency environment is likely to remain very stable," he said. "There hasn't really been a huge move in the euro either up or down in the last year. That is the problem. People are looking for a weak-dollar environment, but what is the credible alternative? There are three currency blocs, all of which are unattractive. We are forced to choose the least unattractive."
The U.S. economy is in or very close to recession, plus there is the massive current-account deficit, which ought to hurt the dollar. Meanwhile Japan "has been in a permafrost recession for a number of years," Mr. Beck said.
That leaves the euro. It seems to be the best of the three - but not really.
"There is a question about the long-term value of the dollar after appreciating for five years," he said. "Medium term, the euro potentially has room to rise, but it is being undermined by a lack of clarity of vision by the European Central Bank."
Not only that, he said, "but in January, euro notes and coins will be introduced, and there could be problems with that, and there has been a lack of clarity in the policy response from the European Union with regard to the crisis" in fighting terrorism.
"I do not think there is a huge currency trade," Mr. Beck summed up. "There is a modest bias to the euro strengthening over time and a modest bias to the yen remaining weak over time."
Henry Hunt, who manages international bond funds at F&C Management Ltd. in London, acknowledged the same pro-euro bias.
"We've had the same view, so we've been wrong too," he said. "We thought the dollar was going to be going into a period of particularly weak growth and be under downward pressure against the euro." The euro, he said, "is trading well below what most economists believe is its purchasing-power parity." That means that goods priced in euros in Europe cost less than the equivalent items in the United States priced in dollars.
Mr. Hunt agreed with Mr. Beck that anxiety over the introduction of euro notes may be capping the euro's value for now. After that, he said, investors are likely to focus on the heavy debt loads of American consumers and businesses and realize that growth prospects are higher in Europe.
"The European economy should do at least as well as, if not slightly better than, the U.S. economy in the next few years," Mr. Hunt said. He added that "imbalances have been run up" in the U.S. economy and that would likely mean "an adjustment must occur that will produce below-trend growth for several years."
A protracted period of slow U.S. growth could produce a sharp fall in the dollar, he said, and that could reignite long-dormant inflation concerns. For dollar-based bond investors, therefore, he suggested a precautionary move out of conventional U.S. government bonds and into Treasury Inflation Protected Securities, whose yields are adjusted for inflation. Currently they trade at 3 percentage points to 4 percentage points above inflation, a healthy real yield.
He added that he did not expect a steep dollar decline, just a gentle one, but that "if the economy performs much more poorly in the next few quarters, I wouldn't rule it out."
Even if the euro and the European economy are relatively strong, "it is more advisable to move assets into bonds than equities," said Mr. Hunt, sounding like a true bond fund manager. A rise in the euro would "tend to be a slight negative" for corporate profits in Europe. "The bond market would like that." He recommended buying longer-dated euro-denominated bonds, where the potential for price appreciation is greatest.
Mr. Hunt then mentioned several factors that could shift the economic balance back in favor of the United States and help support the dollar in the long run.
"The potential rate of growth is higher in America; productivity is higher, the labor force is growing," he pointed out. "There are structural rigidities in Europe. If you do get more growth, there could be supply constraints and inflation." He added: "They need more initiatives to deal with the rigidities in the European economy. Governments need to take a more business-friendly approach."
European leaders have heard the same message for two decades and have not rushed to embrace the American free-market model, even when it seemed to work so successfully in the 1990s. Amid a slowing of the U.S. economy, Europe's social-democratic governments may set a precedent and accelerate the pace of change, but is it something you would want to bet your last dollar on?