Friday, August 22, 2008

Forecast for Dollar

Euro to Dollar in past 5 years

After being in long term decline for several years, the dollar has recently staged a comeback. Will this renewed strength be temporary or does it signal the end of a long dollar bear market?

The present strength of the dollar reflects the fact that the Euro, UK and Japanese economies have come from behind in the race to enter a recession. For a long time, the US looked the most at risk, but, Euro output has shown a marked turn around, recently dropping into negative growth. This has led to a fall in the value of the Euro amidst expectations of lower Euro interest rates. Furthermore, the Euro economy may not recover as quickly as they like. European housing markets are even more overvalued than US housing markets and although they don't have the same sub prime mortgage problems, Europe could see a protracted downturn in house prices.

Problems for the dollar.

The pessimists for the dollar point to underlying weakness in the US economy. Strong export growth, negative real interest rates and tax cuts have provided a temporary fix. But, when exports slow and the tax cuts fade away, the US economy is still left with its sub prime debt, falling house prices, mortgage defaults and weak consumer confidence. I predict the US economy will go into recession in 2009, and there will be little that can be done to prevent it. Whilst the US economy is in recession, the dollar's weakness will remain.

The important question will be to what extent the US can ride out the credit crisis. If mortgage defaults stop rising and if stability can return to the financial system, it may enable the Federal reserve to return to a period of higher (i.e. positive real interest rates). Then the dollar may enter a bull market. But, those are both big ifs.

The long term fundamentals of the dollar still look grim
  • Large current account deficit
  • negative real interest rates (as Fed tries to stimulate growth)
  • low savings ratio
  • Bad debts throughout the financial sector.
The main thing to be said for the Dollar, is that - well it's competitors are just as bad.


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