This past week we learned that U.S. economic growth was 4.8% in the first quarter. That news by itself is positive and ought to have helped the U.S. dollar. But instead the dollar fell against major currencies.
Jennifer Ablan in Barron's wrote in an article Coming to America -- Not (subscription required) that the dollar has fallen against the euro and yen.
The dollar fell to a seven-month low against the euro and a six-month low against the yen. Higher rates make dollars more attractive, so an end to rate increases would hurt the greenback. Friday, the euro rallied to a fresh 11-month high versus the dollar above the $1.26 level during early trading in New York after a host of U.S. economic data came in under expectations. Moreover, central banks, such as Sweden, have been moving their currency reserves out of greenbacks while Russia's finance minister recently called into question the dollar's status as the world's reserve currency.
Marc Chandler, global head of currency at Brown Brothers Harriman, says adding to the euro's strength are the "strong" economic data, such as a rise in euro-zone consumer inflation this month, which raised the probabilities of a rate hike in June from the European Central Bank.
Chen Zhao of BCA Research says that petrodollars may not flow into U.S. bonds but Asian and European central banks "have to buy (the securities) in order to slow down the dollar's drop." These countries do not want their currencies to rally too much, as their economies live and die by exports. In other words, the U.S. may not experience a rerun of Seventies-style recycling in the bond markets, but that will be negated by other factors like central-bank and private-investor purchases.
If the U.S. dollar continues to fall, will that prompt Bernanke to raise rates further? But Bernanke has already hinted that the Fed might want to pause to judge the effects of the recent rate increases. So if he is forced to raise rates to defend the dollar, might he throw the economy into recession? Or would he simply allow the dollar to fall? If speculators sense that he would take the latter approach of letting the dollar fall, then speculative money will leave for other currencies.
I know that there have been a lot of doom and gloom pundits for several years calling for the U.S. dollar to decline. While these pundits have been wrong so far, their luck might change. At present I do not have a strong opinion one way or the other, but I do have exposure to commodities that should help cushion the blow if the dollar were to fall.
Recently I have been rereading George Soros's book The Alchemy of Finance (Wiley Investment Classics)
Anticipating currency moves is notoriously difficult. Soros himself suffered through poor streaks.
I have been speculating in currencies ever since they start floating, but I have failed to make money on a consistent basis. On balance, I traded profitably through 1980 and then chalked up losses between 1981 and 1985. My approach has always been tentative, based more on intuition than on conviction. By temperament, I have always been more interested in picking the turning point than in following a trend. I managed to catch both the rise adn fall of European currencies against the dollar until 1981, but I traded myself out my positions too soon. Having lost the trend, I found it too demeaning to start following the trend followers; I tried to pick the reversal point instead—needless to say, without success. I had some temporary profits in the early part of 1984, but I gave them all back. I was again engaged in a speculation against the dollar at the time I wrote this chapter (April/May 1985). Writing it has undoubtedly helped to clarify my thoughts.
Given the recent economic changes of increased interest rates, higher oil prices, moderating housing pricing, and recent weakness in the U.S. dollar, I cannot help but wonder if the U.S. will see more intensified pressure. Time will tell.
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