FYI | Jul 16 2008
By Chris Shaw
As the US equity market weakens on the back of worsening sentiment towards the outlook for the US financial sector in particular given the issues with Fanny Mae, Freddie Mac and other mortgage companies, the US dollar has also suffered, falling this week to its lowest level since April in trade-weighted terms.
Standard Chartered points out the decline in the US dollar has come as those holding debt in US mortgage institutions have become increasingly nervous about the security of their holdings, given the bailouts being proposed for the two mortgage groups.
Such nervousness appears reasonable, as the last US treasury survey, which dates back to the middle of last year showed around US$1.3 billion of US$6.0 billion in overseas long-term debt holdings were in US mortage institutions, where the outlook is now much cloudier than was the case even a year ago.
But this doesn’t justify such a bearish outlook for the US dollar in Standard Chartered’s view as it doesn’t expect these overseas debt holders will simply rush to sell their holdings and so push down the value of the greenback, particularly as it is questionable how much safer it would be to invest in alternative currencies.
The group argues the fact while the growth outlook remains subdued in the US it is similarly subdued in much of Europe, the UK and Japan yet it is the US that has clearly taken the lead in terms of introducing stimulatory policy measures designed to address this. This means the other regions will have to play catch-up in the months ahead.
This is especially the case in the UK in the group’s view as it sees essentially a policy logjam that brings into the picture the potential for a more pronounced cyclical downturn. Given the lack of policy action it would seem any downturn in the UK would likely be more prolonged as well.
This sets the stage in the group’s view for the next major move in the US dollar to be a rally against the other major currencies, something to which market commentator and trader Dennis Gartman of “The Gartman Report” also recently alluded to.
While not expecting such a rally imminently Standard Chartered suggests the fact a number of US assets and exports now are very cheap when looked at from the point of view of overseas investors should prove supportive for the currency.
This suggests by early next year the trend may well have been reversed and the recent highs of the euro against the US dollar above 1.60 may well prove to be close to the peak of the cycle, particularly if US equities show any signs of consolidation.
