US Dollar May Appreciate Later This Year

In the second half of 2008, investors bought the US dollar as a safe-haven currency. Indeed, the credit crunch was taking over global economy and there very few good alternatives out there. Yet, in the first five months of 2009, like in 2006 and 2007, the greenback depreciated sharply due to spending spree of U.S. government. Looking ahead, we see a potential for gradual Dollar recovery as the US economy starts rebounding and the current account deficit improves.

Certainly, back in 2006, several countries were considered to be in much better economic condition than the United States. For example, during that period, the Euro Area economic growth surpassed that of U.S. and as a result international investors were more willing to hedge dollar exposure with investments into the Euro Zone. Moreover, even though some economic slowdown was becoming more visible in the United States, the majority of economists believed that the slump would be short and there would be no chance of spilling over to other countries. However, few months later the situation changed drastically, and an underestimated slowdown in the world’s biggest economy was soon transformed into a major global recession. More importantly, since everyone was being hit by the recession, the U.S. dollar was being supported by international demand for U.S. government securities.

Nevertheless, during first half of 2009, the safe haven position of the greenback was questioned due to a spending spree by the U.S. government. Indeed, in this fiscal year, the country may borrow $3.25 trillion, almost four times the $892 billion borrowed in 2008. Moreover, it may increase this year budget deficit to $1.85 trillion, equivalent to 13 percent of the nation’s GDP. This will bring the U.S. financial debt very close to unsustainable levels. In addition, with other economies also fighting recession, the yields on U.S. treasuries rose substantially making the fiscal stimulus and central bank actions more pricey than previously estimated. In fact, on June 10, Treasuries fell sharply, pushing 10-year yields to the highest level since October 2008.

Yet, recent data suggests that the pace of U.S. contraction may be slowing. For example, industrial production fell in June at the slowest pace in eight months and consumer and business confidence is steadily improving. Also, at the July FOMC meeting, the Federal Reserve left its $1.75 trillion bond-purchase program unchanged. In addition, there are some signs that U.S. demand is rebalancing from domestic consumption towards more savings and exports. In fact, trade deficit is at the lowest level in 10 years and the current account deficit is improving gradually.  So, looking ahead, the narrowing in the trade deficit is likely to attract more funding than in previous years and make U.S. Dollar more attractive to foreign investors.

Anna Fedec,
7/15/2009 6:58:49 PM