Goldman Capitulation on Dollar Shows Reversal on US

Bloomberg | March 29, 2010 | 10:44 EDT

data0 The strengthening US. economy, subdued inflation and rising stock prices are propelling the dollar rally into its fifth month as traders seek refuge from Europe’s fiscal crisis and Japanese deflation. Goldman Sachs Group Inc. and Citigroup Inc. ended bets on a falling dollar last week after the trades lost 2.8 percent. Strategists are raising greenback forecasts at the fastest pace since last March, just before US stimulus efforts that poured as much as $12.8 trillion into the economy ended the currency’s strongest rally in 28 years. Median predictions for the dollar against 47 currencies tracked in Bloomberg surveys rose an average of 1.4 percentage points in the month to March 24. A year after correctly predicting the currency’s decline and likening it to the fall of Rome, Royal Bank of Scotland Group Plc’s Alan Ruskin said it may soar 22 percent to $1.10 per euro if Greece defaults.

“We’ve moved away from the worst fears,” said Ruskin, the head of currency strategy for RBS Capital Markets in Stamford, Connecticut. “In the US, the economy picked itself up off the ground,” he said in an interview. “Compared to what it might have looked like from the view of March 2009, March 2010 looks very good.” The US Labor Department will report on April 2 that 190,000 jobs were created this month, the most in three years, according to the median estimate of 62 economists surveyed by Bloomberg. The Standard & Poor’s 500 Index has gained 5.6 percent in March, and the latest report on consumer prices showed the cost of living was unchanged in February, ensuring inflation won’t cut off the recovery.

Lagging Growth

Consumer prices in Japan, meanwhile, fell for a 12th month in February, the government reported March 26. The Organization for Economic Cooperation and Development said the same day that the nation’s potential growth rate between 2011 and 2017 will be the lowest among Group of Seven at 0.9 percent. Leaders of the 16-nation euro region sought International Monetary Fund help to respond to Greece’s budget crisis. Portugal’s credit rating was cut one step by Fitch Ratings to AA- with a “negative”     

outlook, meaning there may be more downgrades. “We have clearly underestimated the impact on the euro from the European sovereign crisis,” Goldman analysts led by Thomas Stolper in London said in a March 25 e-mail. “Building consensus among euro-zone members is becoming increasingly difficult,” they wrote, explaining Goldman’s decision to exit the bullish euro bet it made two weeks earlier. “These political headwinds currently matter far more for the euro than the cyclical factors.”

‘Inopportune’ Timing

Citigroup cut its losses on a similar trade after deciding its timing had been “inopportune,” strategists Todd Elmer in New York and Michael Hart in London wrote in a March 25 note. Sentiment toward the dollar is shifting on optimism the currency’s best run since 2008 will be invigorated as Federal Reserve Chairman Ben S. Bernanke stops printing money and raises borrowing costs amid predictions the US economy will grow twice as fast as Europe’s and Japan’s. The dollar gained against all 15 major currencies tracked by Bloomberg last week except the Mexican peso, rising 1.1 percent to $1.3410 per euro, 0.8 percent to $1.4898 per pound and 2.2 percent to 92.52 yen. The Intercontinental Exchange Inc. Dollar Index is up 1.2 percent in March after gaining in each of the past three months.

Playing Catch-Up

The rally has been fueled by Greece’s debt-and-deficit crisis, which sparked speculation the euro region would suffer its first default or dissolve. Forecasters are trying to catch up with the euro’s decline. The median euro prediction has it at $1.36 by the end of the year, down from an estimate of $1.48 in December. The Fed’s printing of dollars last year prompted Royal Bank of Scotland to predict in June the euro would appreciate to $1.40 by the end of 2009. “The psychological impact should not be underestimated,” Ruskin wrote last March of the central bank’s quantitative- easing program. “This is an historic moment — the start of debasement of the world’s reserve currency — and it feels to many participants that in the grand sweep of history we are witnessing the end of ‘Rome’ on the Potomac.” By last week, modern-day fiscal turmoil centered on the ancient city of Athens had prompted Ruskin to reverse course on the euro. “If major contagion occurs, we could go down to $1.15,” he said. “If it looks like one country is going to get cleaved off or there’s a default in the euro area, $1.10 would not be unreasonable.”

Loans for Greece

European leaders agreed last week to provide Greece with a mix of IMF and bilateral loans at market rates if the country runs out of fund-raising options. The accord didn’t specify what events would trigger the plan. Greece is selling 5 billion euros ($6.7 billion) of seven- year bonds today. The securities will be priced to yield 310 basis points more than the benchmark mid-swap rate, according to a banker involved in the transaction, who declined to be identified before the sale is completed. Dennis Gartman, the economist who correctly predicted in June 2008 that commodities would tumble, said the agreement doesn’t solve the euro region’s problems. “This just pastes them over for a short period of time,” Gartman, who publishes a daily market commentary from Suffolk, Virginia, said on Bloomberg Television March 26. “The problem of Greece is just the first. Portugal lies next, Spain behind it, Italy behind that. This is not a pretty picture.”

‘Huge Issue’

Gartman predicted the euro will sink to as low as $1 within three years. The cost of protecting Portugal’s debt from default has risen 151 percent in the past six months, the second most in the world behind Greece, followed by increases of at least 52 percent for the US, France, the UK, Belgium, Spain and Italy, credit-default swap data compiled by Bloomberg show. “The Greek fiscal crisis may be over for now, but sovereign stress is likely to remain a huge issue in the euro area for years to come,” said David Mackie, the chief European economist at JPMorgan Chase & Co. in London, in a March 26 note. Dollar gains may be limited by US investors sending money overseas in search of higher yields as stocks worldwide climb. The MSCI World Index of developed market equities gained 42 percent in the past year as the MSCI Emerging Markets Index rose 66 percent.

‘Reserve Accumulation’

We expect strong flows into emerging markets that will translate into reserve accumulation and diversification into the euro out of dollar,” said Daniel Katzive, a currency strategist at Credit Suisse Group AG in New York, who sees the dollar falling 6.2 percent to $1.43 per euro in three months. “It’s not just about recovery. It’s about how central banks respond to that recovery. We’ve seen the dollar weaken through a US recovery if monetary policy is very accommodative.” At this time last year, the Dollar Index was starting to slide after rising 21 percent in the previous nine months, the quickest gain since 1981, as investors sought the safety of US assets amid the global credit crisis.

Then the Fed began to expand its quantitative-easing program, with $1.15 trillion in debt purchases to shore up credit markets. The currency declined 14.9 percent against the euro, yen, pound, Swiss franc, Canadian dollar and Swedish krona in nine months, the fastest drop since 1987 as measured by the Dollar Index. Now futures traders are more optimistic on the greenback than any time since 1999, the year the European Union’s shared currency was introduced. Hedge funds and other large speculators had 74,917 more wagers the dollar would rise than contracts that profit from it falling as of March 23, the widest gap on record, Commodity Futures Trading Commission data show.

Inflation Mandate

Investors last year placed too much emphasis on the European Central Bank’s mandate to fight inflation when they bet on euro gains, said Marshall Gittler, the chief strategist for the international division at Deutsche Bank Private Wealth Management in Geneva. He predicts the dollar will gain as much as 5 percent this year against the yen as the Fed raises rates. “All the majors are suffering from the same fiscal crises, but just at different speeds and severity; the market tends to target them in rotation,” Gittler said. “The euro’s the one out of fashion right now.” The US economy will expand 3 percent this year, outpacing the 1.1 percent growth in the 16 nations using the euro and 1.9 percent in Japan, the median estimates of as many as 53 economists show. “The US is always faster out of a recession than Europe or Japan; this is a cyclical rally in the dollar,” said Stuart Thomson, a money manager at Ignis Asset Management in Glasgow who helps oversee about $107 billion. He predicts the dollar will reach $1.26 per euro and 100 yen by the end of the year.

Rate Increases

The Fed will start raising its benchmark rate by Sept. 30 as the ECB and policy makers in Japan, the UK, stand pat until at least the fourth quarter, consensus forecasts show. “If you look at what’s happening today, it’s really a dollar move led by rates,” said David Tien, a money manager in New York who helps Fischer Francis Trees & Watts invest $19 billion. Tien predicts the euro will fall to $1.23 by Dec. 31. “So while some might say this is the euro getting destroyed, I take this as more of dollar strength coming through,” he said. John Taylor, who oversees the world’s largest currency hedge fund as chairman of FX Concepts Inc. in New York, predicts the dollar will gain 12 percent to $1.20 per euro by August. “The whole world’s been negative on the dollar since 2002,” said Taylor, who manages $9 billion. “Those people who are calling for the euro to go up are thinking the stock market is going to continue higher and that the euro zone problem is not going to spin out of control. I disagree with both of these things.”


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