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Dollar sinks to new lows
By Neil Dennis and Peter Garnham
Published: November 7 2007 10:08 | Last updated: November 7 2007 11:32
The dollar sank to new lows against sterling and the euro on Wednesday after comments about
China’s foreign reserves from one of the country’s senior politicians.
VIDEO: Testing times
Chris Flood,
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Cheng Siwei, vice chairman of the standing committee of the
National People’s Congress, said China should balance its
$1,430bn reserve stockpile with strong currencies to offset the
weaker dollar.
The euro climbed to $1.47 for the first time, hitting a peak of
$1.4703, while sterling reached a new 26-year high of $2.1053.
Mr Cheng said: ”We should take advantage of the appreciation of
strong currencies to offset the depreciation of weak currencies.”
Although he later tried to play down his comments, saying he had not been speaking in an official
capacity, the damage was done.
The euro rose 0.9 per cent at $1.4687, while the pound added 0.7 per cent to $2.1026.
”We already know that China has been diversifying away from the dollar,” said Lee Hardman at the
Bank of Tokyo-Mitsubishi UFJ.
Capital outflows data from the Treasury department has shown that China has reduced its US bond
and note holdings from $421.1bn in March to $400.2 in August.
Mr Hardman added: ”The dollar sell-off in response is a clear indication of how fragile dollar
sentiment is at the moment.”
Meanwhile, the currencies of commodity producing countries surged to fresh highs as dollardenominated commodity prices hit record levels.
The Canadian dollar rose 1.1 per cent to a record high of $C0.9061 against the dollar, the
Norwegian krone climbed 1.1 per cent to NKr5.2910 and the South African rand climbed 0.5 per
cent to R6.4722.
The Australian dollar also hit a fresh 23-year peak against the dollar after the Reserve Bank of
Australia raised interest rates by 25 basis points to 6.75 per cent and maintained its tightening
monetary policy bias.
“We think that there is a better than even chance that the RBA hikes rates in February,” said David
Woo at Barclays Capital. “We expect the Australian dollar to continue to appreciate toward $0.9500
in the short-term.”
Elsewhere, jitters on global stock markets gave the yen a boost as investors cut back carry trade
positions, in which the low-yielding Japanese currency is used to fund the purchase of riskier,
higher-yielding assets.
The yen rose 1.2 per cent to Y113.28 against the dollar, climbed 0.4 per cent to Y166.20 against
the euro and gained 0.6 per cent to Y237.95 against the pound.
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Falling US rates raise carry trade questions
By Peter Garnham
Published: October 29 2007 21:26 | Last updated: October 29 2007 21:26
Is the dollar set to join the yen and the Swiss franc as a carry trade funding currency?
Both the yen and Swiss franc have been pushed to multi-year lows this year as carry trade
investors have sold the low-yielding currencies to fund the purchase of riskier, higher-yielding
assets elsewhere.
However, the dollar has come under similar pressure in recent weeks, hitting a series of multiyear troughs.
On Monday, it dropped to a record low against the euro, a 47-year low against the Canadian
dollar and its weakest level in 23 years against the Australian dollar. Meanwhile, the dollar
index, which tracks its value against a basket of six major currencies, fell to its lowest level for
34 years.
Expectations of interest rate cuts in the US have been the main driver of dollar weakness, with
the Federal Reserve widely predicted to deliver a 25 basis point cut to 4.5 per cent after its
policy meeting on Wednesday.
A 25bp cut from the Fed would bring US interest rates to the same level as Canada for the first
time since February 2005 and also reduce the dollar’s yield advantage over the euro to the
lowest level since February 2005.
Indeed, markets on Monday moved to price in lower interest rates in the US than in the
eurozone by June 2008.
This is the first time since 2003 that eurozone interest rates have been priced higher than those
in the US, and it means the dollar would have the third lowest yield among the major
currencies, with only the yen and the Swiss franc with lower interest rates.
Analysts say despite the dollar’s absolute interest rate advantage over some currencies, such
as the Canadian dollar, the yen and the Swiss franc, it is the expectation of further currency
losses that is predicted to erode the remaining rate differential.
“FX carry trades not only thrive on the anticipated reduction in a nation’s interest rate against
other nations but also in the resulting decline in the value of that currency ahead of further
interest rate reductions,” says Ashraf Laidi at CMC Markets.
He says the onset of prolonged US interest rate cuts is matched by the likelihood of non-US
interest rates remaining unchanged or even rising in the short-term as in the case of Australia.
“The anticipated reduction of the US yield advantage is the main driver of the dollar’s
deepening losses, which outweigh the current yield advantage of the dollar over these
currencies,” he says.
However, Ashley Davies at UBS says investors should be wary of concluding that declining US
interest rates automatically translate into the dollar being used as a carry trade funding
currency.
He says unlike the yen or the Swiss franc, the dollar is not backed by a country with a large
current account surplus or a large stock of savings ready to be deployed abroad. He also says
volatility in global markets – the lack of which is a crucial factor in the success of carry trade
strategies – appears to have risen structurally following the recent subprime mortgage crisis
and will likely continue to rise next year.
He believes the dollar has been weakening less because of carry outflows and more because
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of diversification activity, as China manages the renminbi against the dollar by buying the euro.
“At some point, the Chinese will desire a stronger currency in trade-weighted terms and when
that happens, official buying of euros will dry up and the relentless downward pressure on the
dollar will cease,” he says.
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