Greenback humbled by concerns over US economy

Greenback humbled by concerns over US economy
By Michael Mackenzie in New York
Copyright The Financial Times Limited 2007
Published: July 11 2007 20:27 | Last updated: July 11 2007 20:27


The dollar’s slide this week to multi-year lows against a number of currencies has come amid a fresh wave of concerns about US economic growth and the sustainability of foreign investor appetite for US assets.

With the Federal Reserve maintaining a steady overnight interest rate and many other central banks continuing to raise rates, the US currency has become less attractive to international investors. This helps to explain why the dollar has fallen to multi-decade lows against the pound and the Canadian, Australian and New Zealand dollars.

The trend intensified on Wednesday when the euro hit a record high of $1.3784 to the dollar and the pound hit a 26-year high of $2.0363.

The yen hit its best level against the dollar for a month, suggesting that investors could be unwinding carry trades, in which they borrow the low-yielding yen to invest in higher-yielding assets.

The catalyst for this latest dollar weakness is concern that the US consumer, for years the mainstay of the economy, could be flagging. Such worries followed evidence that the US housing market still does not appear to be finding a bottom along with news that retailers are suffering.

Subprime mortgages extended to borrowers with risky credit histories were again in the spotlight this week. On Tuesday, rating agency Moody’s downgraded subprime-backed bonds, while Standard & Poor’s placed $12bn of such debt on notice of downgrade, sparking further selling of US corporate bonds and widening premiums, or spreads, for derivatives protecting against default.

“One reason why the dollar has responded in such a negative fashion is that corporate bond inflows have made up half of the current account financing in the past year,” says Alan Ruskin, chief international strategist at RBD Greenwich Capital. “Wider US credit spreads are a dollar-negative event.”

In the 12 months to April, the US received $509bn in corporate bond investment inflows that helped finance the current account deficit.

The latest downturn in the dollar against the euro could have further to run, according to analysts.

“Many investors are asking whether we are entering a new regime,” says David Woo, head of global currency strategy at Barclays Capital.

He noted that the dollar, measured by the Fed’s trade-weighted index against leading currencies, had fallen below a support level that had held for 30 years.

With the dollar in new territory against the euro, Mr Woo says relatively light positions betting against the dollar could accelerate any further decline. With the dollar facing a testing time, investors could start unwinding carry trades.

“The currency market is a two-trick pony, in that it either trades on carry or the dollar,” says Mr Woo. He suspects the market is shifting its focus to the dollar.

The yen has strengthened to a four-week high against the dollar, moving from above Y124 to Y121.02. Still, there has been little evidence of emerging markets taking a hit from the dollar’s woes so far through an unwind of carry trades.

“In general, a broad-based dollar-negative event should not necessarily ensnare emerging currencies,” says Mr Ruskin.

“Provided equities do not go into meltdown mode, carry will probably leak, but not implode.”