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The Dollar Looks Ready to Rally
By KOPIN TAn
DON'T BELIEVE THE obituaries: The dollar isn't dead.
When the Federal Reserve cuts interest rates for a seventh consecutive time this Wednesday, it will begin to wind down a pernicious campaign that has flooded the market with cheap dollars since last summer. At the same time, the whoosh of air from Europe's deflating credit bubble puts new pressure on the European Central Bank to begin cutting borrowing costs in order to goose growth.
The result should be a major shift in global monetary policy that reverses billions of recent short-dollar, long-commodity bets and undercuts high-flying stocks like fertilizer outfit Mosaic (ticker: MOS) and oil-services giant Halliburton (HAL) that earn gobs of money overseas. The strategy shifts by central banks will drive a greenback comeback against the overpriced euro, turning back the 15% slide that since August has lifted the euro -- to a record $1.60 last week -- even as the dollar continues to struggle against the undervalued currencies of emerging Asia.
Monetary policy isn't the only catalyst for a healthier dollar. "A lot of what has happened since last summer also is emotional, and that can change on a dime," says James Paulsen, Wells Capital Management's chief investment strategist. Among other drivers: mounting evidence that the credit crisis loosening its grip stateside is still tightening across the Atlantic, and a growing belief that the U.S. economy could bottom and rebound before Europe's.
The rehabilitation, ironically, is driven by a weak dollar, which makes bargains of our exports, fills Manhattan's 65,000 hotel rooms with European tourists, and entices foreign giants from Ikea to Toyota to open factories here to exploit our increasingly cheap labor.
Already, the dollar has begun to strengthen against commodity-driven currencies from the Canadian loonie to the South African rand, and odds are it is close to a bottom against the euro, sterling and most developed-world currencies. On top of that, "negatives about the dollar are more fully discounted compared to the potential positives," says Marc Chandler, Brown Brothers Harriman's currency strategist, who expects the euro to pull back to test the $1.40 threshold this year.
A Parisian Vacation in 2009? Lower European rates relative to their U.S. peers should help the dollar climb out of its valley.
In the immediate future, the number of foreign central banks hiking rates could still exceed those cutting, "but the margin is narrowing," say Joachim Fels and Manoj Pradhan, Morgan Stanley's London-based global economists. "Looking further ahead, we expect more central banks, especially in the advanced economies, to join the easing path."
In other words, the buckling buck stops here.
JUST HOW CHEAP IS THE DOLLAR? It's at a 12-year low against the yen, and recently suffered the indignity of parity with the Canadian loonie. A euro worth 86 cents in early 2002 now fetches $1.60. Talk-show hosts have referred to it as the "U.S. peso."
It should have been obvious that a dollar bottom is in sight when Brazilian supermodel Gisele Bundchen began demanding to be paid in euros instead of dollars. In an April survey conducted by Merrill Lynch, 50% of global money managers said the greenback is undervalued, up from 30% three months ago, while a whopping 71% found the euro overvalued.
The dollar's ills are well documented, and not all observers see relief at hand. "The U.S. economy continues to get weaker, which undermines confidence in the dollar," the Nobel-prize winning economist Joseph Stiglitz tells Barron's. Meanwhile, "inflation will continue to get worse, and a European Central Bank preoccupied with fighting inflation is unlikely to cut rates," he says.
But how much are these problems already discounted, given the shrill headlines about record gas prices and food riots from Haiti to Indonesia? Financier George Soros recently declared commodities are in a bubble. Our own "Big Money" poll of nearly 120 money managers (see "The Bulls Are Back,") found most waiting for a massive unwinding of the recent short-dollar, long-commodity crush: Nearly three-quarters say they expect the dollar to rise against the euro over the next 12 months, while 66% see commodity prices falling in the next six months.
Of course, the dollar can stay cheap even if everyone agrees it is so. That's why the shift in American and European rate expectations is such a crucial catalyst, since it can unleash a pent-up rush for the exits. As U.S. rates get nudged below 2%, the Fed quite literally must stop easing if it wants to preserve some flexibility for future emergencies.
"It's time for the Federal Reserve to stop" cutting rates "because the likely benefit is small compared to the potential damage," Martin Feldstein, the Harvard economist and head of the National Bureau of Economic Research, declared in an April 15 Op-Ed piece in the Wall Street Journal ("Enough with the Interest Rate Cuts"). Just last week, Federal Reserve Bank of Dallas President Richard Fisher said rate cuts are no longer delivering "bang for the buck." He favors an end to monetary easing.
Things are different in Europe. The European Commission is looking to lower its Eurozone growth forecast below its current 1.8%. But the drumbeat of drab data hasn't peaked -- yet. "Europe is in the biggest credit bubble of all and it hasn't burst yet," says Banque AIG's London-based global strategist Bernard Connolly. "When it does, the euro will fall quite substantially."
SOME COUNTRIES -- BOTH WITHIN the European Monetary Union (like Spain, Greece and Portugal) and outside it (like Ireland and Iceland) -- are grappling with current account deficits, worrisome unemployment and slowing growth in the aftermath of credit and housing booms. Recent German business surveys also indicate weakening activity, and there are signs export growth is sputtering.
"Once a credit-driven boom goes bust in a country that has abandoned monetary independence, as is now happening in Spain, an apparently favorable budgetary position is soon revealed to be very unfavorable indeed," Connolly says. Unless Spain leaves the EMU or the European Central Bank "slashes rates and depreciates the euro massively," the country could face a 7% budget deficit instead of what could otherwise have been a 2% surplus come 2011.
To begin prodding growth, the Bank of England this month took the first step in trimming a key rate by a quarter percentage point to 5%, even as the ECB left its main rate at 4%. That sent the sterling scuttling to near record lows of 1.23 pounds against the euro. Against the dollar, it pulled back from a March peak of $2.04 to $1.96 and is most recently near $1.97. Is that a preview?
Table: Highflier Alert
Though amply reflected in the market, some of the dollar's pains are chronic, and not given to quick fixing. For a start, the ECB takes a hawkish view of runaway commodity costs, while the more dovish U.S. Fed -- so fond of stripping food and energy costs from inflation data, as if Americans do not eat and drive -- sees them as deflationary and ultimately a check on spending and prices.
Peter Thiel of hedge-fund Clarium Capital, who correctly predicted dollar weakness years ago, is skeptical about the convergence of European and American rates -- especially if high oil stays the ECB's rate-cutting hand. "Ultimately, there'll come a point when oil gets high enough for the Fed to stop thinking about stimulating growth and to worry about fighting inflation," Thiel says. That breaking point, however, may not come until oil hits $130 or $140.
That means things could get worse for the dollar before they get better. But with crude already flirting with $119, that once-unfathomable threshold is within sight.
David Woo, Barclays Capital's London-based currency strategist, thinks any one of three factors could bust the dollar out of its downward spiral: a big decline in commodity prices; a major U.S. stock-market correction that sparks a synchronized global economic slowdown or a sustained rise in long-term rates even as the Fed cuts borrowing costs. While the euro might overshoot to $1.63 within the next three months, Woo sees the dollar strengthening over the next year to $1.50 as one of these triggers is set off.
Other concerns persist. Dollar bears fret, for instance, about foreign central banks switching allegiances to other currencies, or oil producers breaking their pegs to the greenback. Axel Merk, who manages the Merk Hard Currency Fund (MERKX) and the Merk Asian Currency Fund (MEAFX), thinks the monumental current account deficits make the dollar still too reliant on inflows from abroad just to maintain its recent levels.
Heavy spending on the Iraq war, a big trade deficit and a mortgage-market meltdown haven't helped the dollar's cause, and the level of dollar holdings as a percentage of the globe's foreign exchange reserves has fallen more than seven percentage points this decade. But at 64%, the buck remains the planet's premier currency, well ahead of the euro's 26.5% and the yen's 3%.
Even as the greenback plummeted in the fourth quarter, dollar reserves held steady near the 64% mark, according to the latest data from the International Monetary Fund. This suggests that "reserve managers are reluctant to sell dollars at these levels," says BBH's Chandler. Also, "foreign central banks have been on a buying spree," and the Fed's custody holdings of U.S. securities for foreign official accounts jumped $145 billion in the first quarter of this year.
The Bottom Line:
The hard-hit U.S. dollar could gain 15% against the euro in the next 12 months. That would take some air out of the highfliers such as Mosaic and Halliburton.
HOW MIGHT A STRENGTHENING dollar affect the stock market? It's probably too early to start picking winners, particularly since some of the likely beneficiaries, like financial-services companies, are facing other, more serious problems than a weak dollar. But energy, technology and capital-goods companies that earn a big chunk of their revenue abroad -- and whose stocks have run up since August -- could give back some of their gains.
Commodity stocks would get hit hardest, since a dollar rebound will hurt both commodity prices and these companies' foreign earnings, says Abhijit Chakrabortti, Morgan Stanley's chief global equity strategist. Industrials will suffer, but to a lesser extent, since "lower commodity costs will offer some margin relief even as these companies' foreign sales take a hit."
Barron's asked the analysts at Bespoke Investment Group, which does customized research, to screen the Russell 1000 for stocks with more than $10 billion in market value and a big clutch of foreign profits, that have run up the most since the dollar's recent slide began. These shares, including names like Apache (APA), Freeport-McMoran (FCX), Southern Copper (PCU) and Bunge (BG), presumably have the most to lose with a rebounding dollar. They're worth keeping an eye on to see how they react.
By KOPIN TAn
DON'T BELIEVE THE obituaries: The dollar isn't dead.
When the Federal Reserve cuts interest rates for a seventh consecutive time this Wednesday, it will begin to wind down a pernicious campaign that has flooded the market with cheap dollars since last summer. At the same time, the whoosh of air from Europe's deflating credit bubble puts new pressure on the European Central Bank to begin cutting borrowing costs in order to goose growth.
The result should be a major shift in global monetary policy that reverses billions of recent short-dollar, long-commodity bets and undercuts high-flying stocks like fertilizer outfit Mosaic (ticker: MOS) and oil-services giant Halliburton (HAL) that earn gobs of money overseas. The strategy shifts by central banks will drive a greenback comeback against the overpriced euro, turning back the 15% slide that since August has lifted the euro -- to a record $1.60 last week -- even as the dollar continues to struggle against the undervalued currencies of emerging Asia.
Monetary policy isn't the only catalyst for a healthier dollar. "A lot of what has happened since last summer also is emotional, and that can change on a dime," says James Paulsen, Wells Capital Management's chief investment strategist. Among other drivers: mounting evidence that the credit crisis loosening its grip stateside is still tightening across the Atlantic, and a growing belief that the U.S. economy could bottom and rebound before Europe's.
The rehabilitation, ironically, is driven by a weak dollar, which makes bargains of our exports, fills Manhattan's 65,000 hotel rooms with European tourists, and entices foreign giants from Ikea to Toyota to open factories here to exploit our increasingly cheap labor.
Already, the dollar has begun to strengthen against commodity-driven currencies from the Canadian loonie to the South African rand, and odds are it is close to a bottom against the euro, sterling and most developed-world currencies. On top of that, "negatives about the dollar are more fully discounted compared to the potential positives," says Marc Chandler, Brown Brothers Harriman's currency strategist, who expects the euro to pull back to test the $1.40 threshold this year.
A Parisian Vacation in 2009? Lower European rates relative to their U.S. peers should help the dollar climb out of its valley.
In the immediate future, the number of foreign central banks hiking rates could still exceed those cutting, "but the margin is narrowing," say Joachim Fels and Manoj Pradhan, Morgan Stanley's London-based global economists. "Looking further ahead, we expect more central banks, especially in the advanced economies, to join the easing path."
In other words, the buckling buck stops here.
JUST HOW CHEAP IS THE DOLLAR? It's at a 12-year low against the yen, and recently suffered the indignity of parity with the Canadian loonie. A euro worth 86 cents in early 2002 now fetches $1.60. Talk-show hosts have referred to it as the "U.S. peso."
It should have been obvious that a dollar bottom is in sight when Brazilian supermodel Gisele Bundchen began demanding to be paid in euros instead of dollars. In an April survey conducted by Merrill Lynch, 50% of global money managers said the greenback is undervalued, up from 30% three months ago, while a whopping 71% found the euro overvalued.
The dollar's ills are well documented, and not all observers see relief at hand. "The U.S. economy continues to get weaker, which undermines confidence in the dollar," the Nobel-prize winning economist Joseph Stiglitz tells Barron's. Meanwhile, "inflation will continue to get worse, and a European Central Bank preoccupied with fighting inflation is unlikely to cut rates," he says.
But how much are these problems already discounted, given the shrill headlines about record gas prices and food riots from Haiti to Indonesia? Financier George Soros recently declared commodities are in a bubble. Our own "Big Money" poll of nearly 120 money managers (see "The Bulls Are Back,") found most waiting for a massive unwinding of the recent short-dollar, long-commodity crush: Nearly three-quarters say they expect the dollar to rise against the euro over the next 12 months, while 66% see commodity prices falling in the next six months.
Of course, the dollar can stay cheap even if everyone agrees it is so. That's why the shift in American and European rate expectations is such a crucial catalyst, since it can unleash a pent-up rush for the exits. As U.S. rates get nudged below 2%, the Fed quite literally must stop easing if it wants to preserve some flexibility for future emergencies.
"It's time for the Federal Reserve to stop" cutting rates "because the likely benefit is small compared to the potential damage," Martin Feldstein, the Harvard economist and head of the National Bureau of Economic Research, declared in an April 15 Op-Ed piece in the Wall Street Journal ("Enough with the Interest Rate Cuts"). Just last week, Federal Reserve Bank of Dallas President Richard Fisher said rate cuts are no longer delivering "bang for the buck." He favors an end to monetary easing.
Things are different in Europe. The European Commission is looking to lower its Eurozone growth forecast below its current 1.8%. But the drumbeat of drab data hasn't peaked -- yet. "Europe is in the biggest credit bubble of all and it hasn't burst yet," says Banque AIG's London-based global strategist Bernard Connolly. "When it does, the euro will fall quite substantially."
SOME COUNTRIES -- BOTH WITHIN the European Monetary Union (like Spain, Greece and Portugal) and outside it (like Ireland and Iceland) -- are grappling with current account deficits, worrisome unemployment and slowing growth in the aftermath of credit and housing booms. Recent German business surveys also indicate weakening activity, and there are signs export growth is sputtering.
"Once a credit-driven boom goes bust in a country that has abandoned monetary independence, as is now happening in Spain, an apparently favorable budgetary position is soon revealed to be very unfavorable indeed," Connolly says. Unless Spain leaves the EMU or the European Central Bank "slashes rates and depreciates the euro massively," the country could face a 7% budget deficit instead of what could otherwise have been a 2% surplus come 2011.
To begin prodding growth, the Bank of England this month took the first step in trimming a key rate by a quarter percentage point to 5%, even as the ECB left its main rate at 4%. That sent the sterling scuttling to near record lows of 1.23 pounds against the euro. Against the dollar, it pulled back from a March peak of $2.04 to $1.96 and is most recently near $1.97. Is that a preview?
Table: Highflier Alert
Though amply reflected in the market, some of the dollar's pains are chronic, and not given to quick fixing. For a start, the ECB takes a hawkish view of runaway commodity costs, while the more dovish U.S. Fed -- so fond of stripping food and energy costs from inflation data, as if Americans do not eat and drive -- sees them as deflationary and ultimately a check on spending and prices.
Peter Thiel of hedge-fund Clarium Capital, who correctly predicted dollar weakness years ago, is skeptical about the convergence of European and American rates -- especially if high oil stays the ECB's rate-cutting hand. "Ultimately, there'll come a point when oil gets high enough for the Fed to stop thinking about stimulating growth and to worry about fighting inflation," Thiel says. That breaking point, however, may not come until oil hits $130 or $140.
That means things could get worse for the dollar before they get better. But with crude already flirting with $119, that once-unfathomable threshold is within sight.
David Woo, Barclays Capital's London-based currency strategist, thinks any one of three factors could bust the dollar out of its downward spiral: a big decline in commodity prices; a major U.S. stock-market correction that sparks a synchronized global economic slowdown or a sustained rise in long-term rates even as the Fed cuts borrowing costs. While the euro might overshoot to $1.63 within the next three months, Woo sees the dollar strengthening over the next year to $1.50 as one of these triggers is set off.
Other concerns persist. Dollar bears fret, for instance, about foreign central banks switching allegiances to other currencies, or oil producers breaking their pegs to the greenback. Axel Merk, who manages the Merk Hard Currency Fund (MERKX) and the Merk Asian Currency Fund (MEAFX), thinks the monumental current account deficits make the dollar still too reliant on inflows from abroad just to maintain its recent levels.
Heavy spending on the Iraq war, a big trade deficit and a mortgage-market meltdown haven't helped the dollar's cause, and the level of dollar holdings as a percentage of the globe's foreign exchange reserves has fallen more than seven percentage points this decade. But at 64%, the buck remains the planet's premier currency, well ahead of the euro's 26.5% and the yen's 3%.
Even as the greenback plummeted in the fourth quarter, dollar reserves held steady near the 64% mark, according to the latest data from the International Monetary Fund. This suggests that "reserve managers are reluctant to sell dollars at these levels," says BBH's Chandler. Also, "foreign central banks have been on a buying spree," and the Fed's custody holdings of U.S. securities for foreign official accounts jumped $145 billion in the first quarter of this year.
The Bottom Line:
The hard-hit U.S. dollar could gain 15% against the euro in the next 12 months. That would take some air out of the highfliers such as Mosaic and Halliburton.
HOW MIGHT A STRENGTHENING dollar affect the stock market? It's probably too early to start picking winners, particularly since some of the likely beneficiaries, like financial-services companies, are facing other, more serious problems than a weak dollar. But energy, technology and capital-goods companies that earn a big chunk of their revenue abroad -- and whose stocks have run up since August -- could give back some of their gains.
Commodity stocks would get hit hardest, since a dollar rebound will hurt both commodity prices and these companies' foreign earnings, says Abhijit Chakrabortti, Morgan Stanley's chief global equity strategist. Industrials will suffer, but to a lesser extent, since "lower commodity costs will offer some margin relief even as these companies' foreign sales take a hit."
Barron's asked the analysts at Bespoke Investment Group, which does customized research, to screen the Russell 1000 for stocks with more than $10 billion in market value and a big clutch of foreign profits, that have run up the most since the dollar's recent slide began. These shares, including names like Apache (APA), Freeport-McMoran (FCX), Southern Copper (PCU) and Bunge (BG), presumably have the most to lose with a rebounding dollar. They're worth keeping an eye on to see how they react.
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