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Tuesday July 13, 2004 - 01:14:58 GMT
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Summertime And The Dollar Is Easing...

Summertime And The Dollar Is Easing...

Apart from the perception that summer markets tend to yield more than the usual share of false signals, this time around it is shaping up as Gershwin's tune from Porgy and Bess...Summertime and the dollar is easing. But any forecast of a lower dollar in the current environment should carry a warning to listeners...anything can happen. An orderly dlr decline that goes with Gershwin's cool blues could become disorderly. Or a snapback in July non-farm payrolls in early August06 could see 50 basis points back on the radar screen for August10 FOMC meeting.

If you sense any hesitancy on my part to boldly call a resumption of the long-term downtrend and sell dollars with abandon it is because I have been there several times since the dollar bounced in February and I have been shot down more or less each time by a resilient dollar. And as I started out saying it is summer and reading moves for trends is as treacherous as it can get in the forecasting business.

So I am giving a Gershwin sell easy move lower (no lights out) and one backed this week by the removal of Japan election (reform) risk, a likely record or near-record US May trade deficit Tuesday, a steep decline in US June retail sales on Wednesday, little to no change in US June industrial production Thursday and modest US June PPI Thursday and CPI Friday. But because it is summer do not look for major positioning. The market reaction to the Japanese election should be a sign of what is to come this week with the US data releases. Flurries of dollar selling followed by flurries of short covering leaving the dollar modestly lower at the end of the week is about as bold as summer forecasting warrants.

That said it is increasingly evident that market participants are again comfortable with a structurally weak dollar. Funding the US current account deficit is worry that has renewed appeal. Tuesday's trade deficit could elevate this concern even if the deficit narrows from April's record (unlikely due to oil prices, mixed foreign demand and solid US imports ex-oil). Admittedly if this concern were elevated, the dollar would be falling more quickly than it is currently. But assuming ever increasing need for foreign savings will be met without an appreciable decline in the dollar and higher US interest rates is a summer daydream. A trade deficit running at $45-50bln a month is unsustainable without some serious pressure on the dollar and rates.

While not all are ready to buy into the structural story as a case for selling dollars, the notion that the US economy is moderating and underscores the Fed's preference for a measured pace in tightening has turned the cyclical story on its head as far as the dollar is concerned. Aggressive Fed tightening is a necessary condition for a higher dollar. A measured pace to fed tightening leaves the dollar exposed to structural sellers. And if US data continue to call into question high growth, low wages, high productivity, solid employment growth and strong consumption as has been the case to a greater or lesser extent in the last several weeks, then the case for an orderly dollar decline is defensible.

It is worth noting that dollar/Swiss is nearing the January low of 1.2135, the lowest level since September 1995. Similarly it is reasonable to look for new dollar lows versus the euro (1.2930 February high), the yen (103.40 March low) and sterling (1.9140 February high) later this year barring a resurgence in US economic activity. And it goes without saying that the steady decline in the dollar has little to do with the comparative attractiveness of the outlook for the Euro Zone and euro (Japan is another story...economy making a comeback). It is about reaching limits in the willingness to feed the beast of US consumption. At some point in the supply of assets by deficit countries, surplus countries become sated for relative rate of interest and risk. If this condition emerges ahead I believe we are still early in the decline of the dollar and it will take lots of finessing by US and G7 authorities to prevent it from becoming disorderly.

David Gilmore


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