Columbia University professor and Nobel Prize-winning economist Joseph Stiglitz is the latest commentator to weigh in on the debate about the dollar, saying Friday that the US currency’s role as a good store of value is “questionable” and warning about the USD’s high degree of risk.
Stiglitz told a conference in Bangkok that the world needs a “global reserve system,” reports Bloomberg. Support from countries like China should ensure orderly discussions on a new reserve system, he added.
The dollar has lost 12 per cent since March 5 against an index comprising the euro, yen and four other major currencies – all the while, China, the world’s largest holder of forex reserves, Russia and the other Brics have been calling for a new global currency to replace the dollar as the key reserve currency.
The current reserve system is “in the process of fraying,” said Stiglitz, adding: “The dollar is not a good store of value. Right now, the dollar is yielding almost no return and yet anybody looking at the dollar has to say there’s a high degree of risk”.
Bloomberg quotes Pimco portfolio manager Curtis Mewbourne, who predicts the dollar will weaken as the US pumps “massive” amounts of money into the economy. But others, including David Woo, BarCap’s global head of forex strategy in London, argue that pessimism over the dollar’s prospects may be excessive and that its status as the world’s reserve currency is still intact.
“The reserve currency issue was a big issue three months ago,” Woo told Bloomberg TV on Thursday. “But guess what? The dollar hasn’t gone anywhere over the last three months for the most part and if anything, we’ve seen a slowdown in dollar-selling by central banks.”
Lex agrees that reports of the dollar’s impending death are greatly exaggerated. In a recent note, it wryly observes that “just like uncomfortable teenagers, markets love ‘normal’ and rail at the different or quirky.”
But investors must be consistent: amid new optimism about rebounding stock markets and reviving bonuses, exchange rates should be looked at in traditional ways too, it admonishes, noting: “That means goodbye to wailing speculation about the death of the dollar in favour of currencies that few investors can even spell.”
Turning to the “tried-and-tested metrics say”, Lex looks at recent Deutsche Bank research which focuses on three indicators, all suggesting that dollar weakness since March has been overdone. It says:
On a trade-weighted basis, versus historical trading bands, the dollar is 12 per cent below “fair value”. It is even more undervalued against the euro and commodity currencies such as the Australian dollar.
The dollar also tends to move with changes in the sum of the US current account deficit plus portfolio flows (roughly the supply and demand for dollars on international capital markets). By this measure the dollar is slightly cheap. It is also undervalued when comparing interest rate differentials, especially if America is first to emerge from recession and yields on 10-year Treasuries march higher.
Of course, plenty of things move currencies in the short-term. During the past three months, the dollar’s changes against the euro, for example, have moved most closely with the oil price — a higher oil price worsens the current account deficit and is, therefore, bad for the dollar; or risk indictors such as the CBOE’s Vix index — because traders flock to the dollar whenever there is a peep of bad economic news. Still, the dollar now looks a good bet. Those in the “normal’ camp can buy it on fundamental grounds, while the hell-in-a-handcart crew knows it’s a safety play.
As for the currency markets and the often-favoured USD/JPY trade, CMC Market’s chief market strategist Ashraf Laidi had this to say in a mid-week note:
We reiterate last week’s chart in USD/JPY (currency pair with 2nd highest daily turnover after EUR/USD) highlighting the resurfacing of cyclical peaks (occurring every 4 weeks at 1st week of every month) giving way to a possible 92.00 as early as week’s end. We continue to expect a revisit of the Jan lows of 87 before end of Q3.
The latest peak in the USD/JPY chart occurred on Aug 7th as a result of better than expected US jobs report on Aug 7th, which fuelled speculation that USD was breaking away from its 10-month old trend of moving opposite to equities. Since it takes at least one week before trends are confirmed dead or born, the subsequent trading setup throughout USD and JPY pairs continues to follow risk dynamics, hence the relationship remains established. While much blame is placed on China’s accelerating equity losses, their importance is underlined by their simultaneous occurrence with the lack of any positive news from the all important US consumer.
Fundamental Rationale for Declining USDJPY: Emerging signs of economic stabilization in Japan may have in the past been accompanied by subsequent declines in JPY as improved Japanese investor appetite encouraged outflows into foreign equities. But With Japanese equity indices outperforming their G7 counterparts (Nikkei-225 and Topix-20 +15% and 13% respectively YTD), the usual capital bleed from Japan is not taking place. And with the Bank of Japan maintaining its economic assessment unchanged, indicating a bottom in the pace of deteriorating, the case for the yen is far from over.
FX Seasonals 80% Correct The usual repatriation by Japanese institutional investors ahead of the end of the first half of the fiscal on Sep 30 has also contributed to selling pressure during August. USDJPY ended August lower in each year of the last 10 years with the exception of 2006 and 2008. Such 80% consistency for the pair gains a solid boost in 2009 due to the aforementioned factors.
As for other USD pairings, in Laidi’s view:
There’s no change in our positive medium-term assessment for USD against GBP and CAD continues to play out, with both currencies under broadening pressure, courtesy of prolonged QE from the BoE, ongoing banking concerns, deteriorating oil/gas fundamentals and dovish currency rhetoric. GBP/USD makes [Tuesday's] CPI news an event of the past after BoE Governor King was revealed by the MPC minutes to have voted for a higher £75bn in new QE (along with 2 other members), more than the agreed upon £50 bln.
GBP/USD fell below our $1.64 target (55-day MA) and is slated for further losses towards $1.6050 and followed by $1.5780 into end of Q3. Upside remains capped at $1.6570. EUR/USD continue to struggle below $1.42 as bearish bias suggests $1.3990 is the more immediate concern. $1.3840 to stand as the key support for now. USD/CAD attained the 1.1120 target last week and is seen extending its ascent towards 1.1180 as the next key objective. This level is presented by (i) the 55-day MA (ii) 50% retracement of the decline from the 1.17 high in July (iii) trend line resistance from the said high. We could see a climb towards interim resistance of 1.1120, before extending to 1.1180 later in the day, depending on the extent of selling in Wall Street (Dow futures -85 pts).
Related links:
China’s Treasury confidential – FT Alphaville
Dollar slips vs euro on data – Reuters
Brics confounded on dollar debate – FT Alphaville