The U.S. dollar faces a long list of challenges in the New Year.
The U.S. greenback could strengthen in 2011-but only against the European euro and other currencies with heavy exposure to the European debt crisis, including the British pound sterling. Against virtually every other currency, however, the U.S. dollar is likely to be the loser.
In short, the outlook for the dollar in the New Year depends almost entirely on which currencies you're comparing it with.
Not surprisingly, the euro is in for a rough time.
In a just-released survey conducted by Bloomberg, the three currency strategists with the best track record over the last 18 months say that the worst is yet to come for the euro in relation to the dollar.
In fact, these strategists expect that the euro's slide will continue into the middle part of next year – extending what's already been the worst year for that currency since 2005.
Top-rated forecaster Standard Chartered Bank, which has operations in 70 countries around the world, predicted the euro could weaken to less than $1.20 by June, down from about $1.33 now. The No. 2- and No. 3-ranked analysts – Australia's Westpac Banking Corp. and Wells Fargo & Co. (NYSE: WFC) – both said they were "bearish in the short term," with Wells Fargo actually cutting its 2011 outlook for the euro on Dec. 3.
The concerns about the euro were echoed by John Taylor, chairman of FX Concepts LLC, the world's largest currency hedge fund. Speaking at the New York Hedge Fund Conference on Dec. 2, Taylor said that "we have a long way to go before the situation in Europe is resolved. The risk that Spain and Italy will get into trouble is going to cause the euro to get quite weak."
Simon Ward, chief economist for London's Henderson Global Investors, agreed, saying that, from a European perspective, U.S. monetary trends "continue to strengthen," based on "hopes of faster economic growth in the first half of 2011." Ward also said that "QE2," the U.S. Federal Reserve's recently announced second round of monetary easing – which many experts contend will weaken the dollar versus the euro – was "at best, unnecessary."
The projections were supported somewhat by the recent trend in the U.S. Dollar Index (DXY), which tracks the dollar against a basket of currencies that includes the euro, yen, pound, Canadian dollar, Swiss franc and Swedish krona. The index, which had slumped after hitting a high above 88 in June, rallied steadily through October and November, moving back above 81 on Nov. 26.
The index sagged briefly at the start of the month, but bounced again after Federal Reserve Chairman Ben S. Bernanke told the CBS News magazine "60 Minutes" on Dec. 5 it was "possible" the Fed might boost purchases of U.S. securities beyond the $600 billion already announced.
Because of uncertainty about the impact of QE2 and Europe's efforts to resolve its debt crisis, the gloomy outlook for the euro versus the dollar isn't universal. In fact, once it got beyond the predictions of Standard Chartered, Westpac and Wells Fargo, Bloomberg's survey of 41 currency analysts found the median projection for the euro in mid-2011 rising to $1.36, from an earlier forecast of $1.35.
"There will be sufficient political will to find measures that will bind the system together," currency strategist Jane Foley of Dutch-based Rabobank Group told Bloomberg. "The euro will come out of this stronger."
That's supported by the Financial Forecast Center, an independent economic research service, which predicts the dollar will hit a high of 1.424 euros in January, then fall steadily to just 1.251 euros by June of 2011.
The other major currency against which some analysts feel the dollar may rally in 2011 is the Japanese yen, though that could come about because of deliberate Japanese government efforts to weaken the currency in order to improve the nation's export circumstances. Currently, the yen stands near its strongest level in 15 years, reflecting the demand from many Asian countries seeking to shift their reserves from dollars to yen.
The possibility of Tokyo making new efforts to weaken the yen recently prompted Goldman Sachs Group Inc. (NYSE: GS) to lower its projections for the currency. Thomas Stolper, an economist at Goldman's London office, said the firm now expects the yen to reach 90 per dollar in 2011, versus an earlier forecast of 85. The Financial Forecast Center's outlook for the yen was in line with Goldman's as it predicted the yen would move from 82.1 to the dollar in January to 88.2 in June 2011.
Dark Days for the Dollar?
On the flip side of the dollar bill, there's a long list of currencies against which the dollar could weaken in 2011 – and a broad array of analysts who expect it to do so.
At the top of the latter list is Money Morning Chief Investment Strategist Keith Fitz-Gerald. Says Fitz-Gerald: "I fully expect the dollar to continue to disintegrate in 2011."
Given the continuing crisis in Europe, Fitz-Gerald predicts the dollar will have "a few spurts to the upside," as news stories of new problems surface. But he says that these will be "nothing more than brief, tactical opportunities for short-term currency traders."
"Longer term, we know that a weaker dollar is inevitable based on the laws of economic reality," says Fitz-Gerald, who calls the Federal Reserve's efforts to deal with the ongoing financial crisis "a Keynesian fantasy."
Fitz-Gerald believes that central bankers in most of the world's most-developed countries are taking the wrong monetary approach – reiterating his oft-stated theme that "no nation in recorded history has ever bailed itself out by debasing their currencies the way the central bankers are doing now. Ever!"
There's some support for Fitz-Gerald's position within Bernanke's own team, as well as from a few foreign monetary officials.
Philadelphia Fed President Charles Plosser, addressing an economic seminar in Rochester, N.Y., said he "remained skeptical" that the Fed's monetary easing would help in stimulating the economy and thought a weaker dollar and a renewal of inflation in the future would be a likely result.
While not withdrawing his support for the Fed bond-buying program at this time, Plosser said if it didn't quickly deliver the hoped-for economic benefits, the Fed should "rethink its analysis" of the program, "not infer that we merely need to increase the size" (as Bernanke said was possible in his "60 Minutes" interview).
Dutch Financial Minister Jan Kees de Jager also said on Dec. 5 that he thinks too much attention is being focused on the euro and not enough on what could be bigger problems ahead for the dollar and yen.
"The euro will prevail," Kees de Jager told the Dutch TV program "Brandpunt." "Then the markets will again look at other countries … which have much bigger problems with government finances" – most notably "Japan, which has twice its economic size in debt" and the United States.
Replacing the Dollar?
Also predicting hard times ahead for the dollar is French President Nicolas Sarkozy, who just took over the chairmanship of the G-20 economic alliance, which collectively accounts for 85% of the world's gross domestic product (GDP). Sarkozy, who has long criticized the dollar's role as the world's reserve currency, claiming that it has contributed to global credit and trade imbalances, sees the dollar losing ground to both the euro and the Chinese yuan.
Barry Eichengreen, an economist at the University of California at Berkeley – who is also an expert on the global monetary system – agrees with both Fitz-Gerald and Sarkozy – at least in some respects. Like Sarkozy, he feels that Europe's euro and China's yuan will both gain in strength and status relative to the dollar. And, like Fitz-Gerald, Eihengreen feels that will happen not because of some outside threat from China or other countries, but "from America's own mismanagement and growing indebtedness."
In his new book "Exorbitant Privilege: The Rise and Fall of the Dollar and the Future of the International Monetary System," due out in January, Eichengreen predicts the world will eventually develop a multi-currency system, with several currencies sharing the role of storehouse for global reserves.
A hint that such a shift may already be under way came Nov. 23 when China and Russia announced that they would "renounce the U.S. dollar" and instead begin using their own currencies (the yuan and ruble) for trade between the two countries.
Short-term, however, Eichengreen says the dollar will remain the reserve currency of choice, if only because of the deep and liquid U.S. financial markets and America's dominant trade position. According to the International Monetary Fund (IMF), 61% of all global currency reserves are still denominated in dollars, though that is down from 66% in 2002-2003.
As Money Morning's Fitz-Gerald has done in the past, Eichengreen also discounts the possibility that China might begin the wholesale dumping of its dollars and dollar-based assets since, given the size of its holdings (now approaching $3 trillion), it "would, in effect, only be hurting itself."
A Bloomberg survey of 22 economists projected the Chinese yuan, or renminbi (RMB) as it's referred to inside China, will rise from a recent quote of 6.37 per dollar to 6.15 in 2012, based on an expected follow-up to Beijing's decision last summer to let its currency appreciate by 2.5%.
The Commodities Factor
Other currencies expected to show increasing strength versus the dollar in 2011 include the Canadian dollar (CAD), Swiss franc (CHF), Australian dollar (AUD), Brazilian real (BRL), Turkish lira (TRY), the Russian ruble (RUB) and, later in the year, both the British pound (GBP) and euro (EUR). All were recently rated "outperform" by Canada's Scotia Capital, a leading international-currency-trading and analytics firm.
The dollar also appears destined for weakness in absolute terms in 2011, based on price projections for major commodities denominated in dollars. A number of banks, brokerages and independent analysts have raised price projections for gold, silver, oil and other products in recent weeks, largely based on their projections of a falling dollar.
For example, in an article published Dec. 2, Money Morning Contributing Editor Peter Krauth upped his estimate for 2011 gold prices to $1,900 an ounce, citing four reasons why he believed such a dramatic move was coming.
Money Morning Chief Investment Strategist Keith Fitz-Gerald recommends that you go long the Swiss franc, the Australian dollar and the Chinese yuan, either directly in the foreign-exchange or futures markets – or, for more risk-averse investors who prefer a less volatile approach, using exchange-traded funds (ETFs) that focus on those currencies. Some top ETF candidates include:
- PowerShares DB U.S. Dollar Index Bearish (NYSEArca: UDN), recent price $26.73: This "inverse fund: moves up in price when the dollar declines against a basket of six currencies, meaning you're just betting on a weaker dollar, not an advance by one single foreign currency. However, given other opportunities and the speculative nature of the currency markets, Fitz-Gerald advises limiting your investment to no more than 2% of your investable capital.
- CurrencyShares Australian Dollar (NYSEArca: FXA), recent price $98.92: This fund invests in baskets of trusts shares (issued in units of 50,000) backed by Australian dollars deposits, thus directly tracking the exchange rate with the U.S. dollar. The fund has a recent market capitalization of $665 million.
- WisdomTree Dreyfus Brazilian Real (NYSEArca: BZF), recent price $29.28: For investors seeking exposure to the blossoming South American markets, this fund is a good choice. It tracks exchange rates between the Brazilian currency and the dollar. Market cap is $148 million.
- Market Vectors Chinese Renminbi ETN (NYSEArca: CNY), recent price $40.1: An exchange-traded note (ETN) – rather than an ETF – this fund tracks the S&P Chinese Renminbi Total Return Index, which follows the exchange rate of the dollar against the yuan. The fund has a fixed number of shares (1 million) and a recent market capitalization of roughly $25 million.
- WisdomTree Dreyfus Emerging Currency (NYSEArca: CEW), recent price $22.99: If you think the world's developing economies are likely to outperform the developed nations – and want to profit if their currencies also appreciate – this fund is a solid option. It tracks currency values and interest rates of emerging nations in Asia, Latin America, the Middle East and Africa. Market cap is $293 million.
For later in the New Year, if the situation in Europe stabilizes somewhat, you might also consider:
- CurrencyShares British Pound Sterling Trust (NYSEArca: FXB), recent price $155.90: This fund will rise as the British pound regains some of the ground it has lost against the dollar due to its exposure to the Irish debt crisis. Current market cap is about $150 million.
- CurrencyShares Euro Trust (NYSEArca: FXE), recent price $132.23: This fund will rise in price when the euro finally begins to regain ground against the dollar. The market capitalization is $354 million.
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