US Dollar Looks Oversold

The combination of a weak economy with quantitative easing and a rising appetite for risk has brought the US dollar to its lowest level against the euro since the begging of the year. Moreover, although the recent data suggests that the pace of U.S. contraction may be slowing, the biggest economy in the world is far from a sustainable recovery.

Indeed, most of the improvement in consumption and housing market has been coming from the government pumping money into the economy. For example, consumers have benefited from the cash-for-clunkers” plan and extended jobless benefits aimed at stimulating spending. In addition, a spending spree by the U.S. government is worrying many investors. In fact, 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 which will bring the U.S. financial debt closer to unsustainable levels.

In addition, there has been more speculation about the dollar reserve currency status. Although it is unlikely that the US currency will lose its position, SDR-denominated debt issued by the IMF may create a competition for US Treasuries. Furthermore, looking at the size of dollar FX reserves accumulated during recent years even a marginal reduction in Dollar holdings could have a significant impact on financial markets.

Nevertheless, at Trading Economics, we think the US dollar will strengthen. 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 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,
9/10/2009 7:54:01 PM