Monday, August 25, 2008
Historical Trends Suggest That the Buck Is Back - WSJ
After Dollar's Long Decline, Investors Wonder Whether a Turning Point Is Here The dollar's bounce in recent weeks has investors wondering whether this is the beginning of the end of its extended slide. Such a turning point would be one of only a handful over the past 30 years. Since the late 1970s, the dollar has experienced long, deep, multiyear trends, veering from superstrong to feeble and back. These currency cycles have tended to last from five to seven years in each direction. By that standard, the dollar's decline, now more than six years old, is looking long in the tooth. The dollar touched its recent peak versus the euro in late 2001, and against a broader group of currencies in early 2002. "The biggest question I get is, 'Has the dollar embarked on a seven-year uptrend?'" said Parker King, head of currency investing at Putnam Investments. Some of his clients have started to prepare for that eventuality, he said, by changing their level of exposure to the dollar's movement. The dollar's latest gains -- it is up 8% versus the euro and 5% against the Japanese yen since mid-July -- have been grounded more in pessimism about growth prospects elsewhere than in optimism about those of the U.S. Recent data have confirmed that economies in Europe and Japan are weakening. The dollar also has benefited from lower oil prices, as the two have tended to trade in opposite directions. The U.S. credit crunch, housing slump and other baleful indicators are far from enticing. "These are some of the worst U.S. fundamentals I've ever seen for a [dollar] turn," said Alan Ruskin, chief international strategist at RBS Greenwich Capital. "Nonetheless, it does look like a turn." The record shows that major changes in the dollar's direction take time to unfold and rarely are smooth. In each case, the dollar reached a point of extreme weakness or strength before heading in the other direction. The current slide seems to follow that pattern: From its peak in 2001 until its low last month, the dollar lost nearly half of its value versus the euro, reaching a level that currency experts say is about 30% too cheap based on economic fundamentals. Still, currencies are known to overshoot such theoretical targets, sometimes for long periods of time. At certain points, the cycle began changing only after governments intervened directly in the currency markets. Punchstock So far, there is no sign of such coordinated government intervention, which helped jolt the dollar into moving in different long-term directions in 1985 and 1995, for instance. In 1985, governments intervened to prevent a strong dollar from becoming stronger; in 1995, they did the opposite. Capital flows also play a role in major turns in the dollar, as investors re-evaluate where to put their money around the globe. Around the time of the previous big shift in the dollar, the dot-com bubble popped and a U.S. recession followed. That prompted the Federal Reserve to slice interest rates dramatically, making dollar-denominated investments less enticing. Now tentative signs have emerged that things are turning more positive for the buck on that front. There are stronger inflows coming into the U.S. in search of bargains on mergers and acquisitions. The net total of such deal-related inflows now in the pipeline touched its highest point in seven years at the end of July, according to Bank of America. At the same time, U.S. investors are no longer sending massive amounts of money abroad in search of profits. Mutual funds that focus on investing abroad had net inflows of $9 billion in the first six months of this year, compared with more than $80 billion in the same period last year, according to the Investment Company Institute. Another possible positive for the dollar: Exports are rising, so the U.S. trade deficit is declining. In June, exports registered their largest monthly jump in more than four years. By making U.S. goods more competitive overseas, the dollar's long weakness has helped to mitigate some of the large imbalances in the global economy. However, some investors say that without signs of improvement in the overall U.S. economy, an upturn in the dollar remains unlikely. One condition for the dollar's rally to be sustainable "is that the U.S. economy stabilizes, and that's a huge gamble," said Maxime Tessier, head of foreign exchange at the Caisse de dépôt et placement du Quebec, Canada's largest pension fund, with $155 billion under management. Private investors overseas aren't rushing to buy U.S. stocks and bonds because of such leeriness about the U.S. economy, noted a recent report from Goldman Sachs, a factor it said it would be monitoring closely to gauge the dollar's future trajectory. Even some who think the dollar is bottoming are cautious. David Rolley, who manages $23 billion in global bonds at Loomis Sayles, has been holding more assets in dollars than his benchmark index recommends. Despite the dollar's recent gains, "We're not brave enough to add to [that] trade," he said. "There's still grief and consternation out there."