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13.5.06

DECLINING DOLLAR

The continuing sell-off came amid a series of events that should, in theory, have aided the greenback. The Federal Reserve released a broadly hawkish monetary policy statement, Thursday’s US trade data was far better than feared, and the US Treasury declined to formally cite China for currency manipulation, a ruling that would have been expected to drive further Asian gains against the dollar.
Yet sentiment has turned so decisively against the greenback that it still fell, sliding a further 1.1 per cent to $1.2879 to the euro, 2.1 per cent to $1.8897 against sterling and 1.9 per cent to SFr1.2022 against the Swiss franc, hitting new one-year lows against each, and 1.3 per cent to Y110.50 against the yen. The dollar has now lost 6-8 per cent against each of these currencies since the start of April.
The selling has been driven by two major factors. First, relative interest rate differentials continue to move against the dollar.
Despite the Fed statement, the market is only pricing in a 40 per cent chance of a June rate rise. In contrast there is increasing talk that the European Central Bank may sanction a larger-than-expected half-point rate rise next month, that Japan could initiate its first hike of the cycle as early as next month, and that the Bank of England may raise rates before the year is out.
Second, since last month’s G7 conference, markets have increasingly focused on the massive US current account deficit, some 7 per cent of GDP, and the role that a weaker dollar will almost certainly have to play in order to bring this imbalance back to a more sustainable level.
“The structural imbalances in US international trade flows remain significant and we believe forex market participants will become more concerned over the burgeoning US current account deficit and that this will contribute to a weakening dollar,” said Mitul Kotecha, head of global FX research at Calyon.
The repercussions were felt by a host of emerging markets on Friday, sending the Brazilian real down to R$2.1355 to the dollar, a fall of 4 per cent on the week; the South african rand to R6.2348 to the dollar, down 3.1 per cent; the Turkish lira to TL1.3965 to the dollar, down 6 per cent, and the Hungarian forint to Ft266.04 to the euro, off 2.3 per cent.
Carry trade investors, such as hedge funds, were said to be cutting their exposure to emerging markets amid rising volatility in the major currencies in which they borrow and mounting risk aversion as concerns over inflation spike higher.
“High yield emerging market currencies are weakening and the lower yielders are outperforming,” said Mansoor Mohi-uddin at UBS.
In contrast, the Russian rouble breached the Rbs27 barrier against the dollar for the first time since January 2000, rising 0.5 per cent to Rbs26.95 over the week, as President Vladimir Putin pledged to make the rouble fully convertible by July.

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