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Authors for macroblog are Dave Altig, John Robertson, and other Atlanta Fed economists and researchers.

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May 23, 2006

Why Betting Against The Dollar Is Tricky Business

In the craps shoot that is economic forecasting, few games favor the house more than trying to predict exchange rates.  Perhaps as a consequence, I was taken by this, from the Wall Street Journal (page A1 in the today's edition):

Stocks in developing countries tumbled yesterday, extending one of their biggest losing streaks in nearly a decade, as growing jitters about the global economic outlook amid rising interest rates prompted investors to abandon riskier markets world-wide...

Driving the sell-off: Expectations that central banks around the world, from the U.S. to Europe and eventually Japan, may be preparing to raise rates more aggressively than previously anticipated. News last week that the U.S. consumer-price index rose faster than expected raised the specter that interest rates will have to climb further to curb inflation. Even the recent retreat in commodity prices has not been enough to blunt inflation fears, and since many developing countries are commodity producers, these declines have weighed on their economic outlooks...

... given the current global economic scenario, "these markets are going to be in for a rough couple of months," said Carlos Asilis, a Miami-based portfolio manager for Vega Plus Capital Partners, which has $2 billion under management.

Here's a reminder of how global economic stress tends to affect the value of the dollar:




Of course, the current circumstances are a long way from the full blown crises in the latter 1990s.  And things improved today...

Emerging markets outside Asia began recovering from Monday's selloff, tracking rebounds in commodities and gains in most developed-market equities.

Although Monday's selloff followed two weeks of declines that reduced, if not wiped out, many of the gains so far this year, investors are showing signs of resilience.

"What you've seen over the past week or more has primarily been a case of position reduction as risk appetite has declined," said Stephen Gilmore, a global emerging-markets strategist for Banque AIG, a unit of AIG Financial Products Corp. "It's always very hard to know how long risk reduction will continue. I don't think things [in emerging markets] fundamentally have changed."

... and you might argue that the U.S. is particularly poorly positioned in the current environment.  On the other hands, The Skeptical Speculator noted that, at least yesterday, "US stocks were relatively resilient compared to the other stock markets"; in Euroland French business confidence is slipping and German investor sentiment stumbled as Eurozone industrial orders fell;  and the Bank of Japan has yet to show any urgency in moving short-term rates away from zero.

All of which may amount to exactly nothing.  I, along with many others, fully expect the trend in U.S. current account deficits to reverse -- really, any day now -- and I will be less than shocked to see a depreciation of the dollar along with that adjustment.  But to anyone waiting for the greenback slaughter, I have one question: If, heaven forbid, the global economy goes south, who ya gonna call?

UPDATE: Steven Poloz thinks "emerging global conditions point to a stronger U.S. dollar, not a weaker one."  John Palmer doesn't think so.

ANOTHER UPDATE: Menzie Chinn discusses the impact of dollar depreciation on domestic inflation, at Econbrowser.

YET ANOTHER UPDATE: I finally caught up with Brad Setser's post, making much the same point, but with a lot more numbers to back his case.

May 23, 2006 in Exchange Rates and the Dollar | Permalink


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» The dollar and interest rate expectations from Econbrowser
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I did not like today's action. I did not like the momentum of the trade. It feels like to me that the market is going to take a big S*^%. Too much fear. Too much uncertainty. Maybe not 1987, but 1989?

Posted by: jeff | May 23, 2006 at 10:52 PM

What you watch for is signs of stress in the system.

A prime example is what we have been experiencing recently --
a rise in the spread between US and foreign bond yields that is accompanied by a weakening dollar.

Normally, rising spread should cause a stronger currency. If it
doesn't watch out.

Posted by: spencer | May 24, 2006 at 04:00 PM

David -- i did an even longer response to you "who are you gonna call question"

Posted by: brad setser | May 26, 2006 at 01:18 PM

I don't doubt that a weaker dollar, ceteris paribus, will improve the US competitive position vis a vis the other OECD countries. On the other hand, a weaker dollar will do next to nothing to improve our competitive position vs. China and other low wage countries. Chinese workers in manufacturing earn $5-10 per day, vs the $10-20 per HOUR that US manufacturing workers earn. One can make a similar comparision to countries such as India and Indonesia.

Furthermore, oil remains an important part of our import bill. As Matthew Simmons pointed out in his book "Twilight in the Desert," world oil production may well be close to peaking and its real price cannot be expected to fall over the intermediate term (I am disregarding day to day and seasonal fluctuations here). In addition, Iran and Russia have stated that they want to sell their oil for currencies other than dollars. That would most likely increase the dollar price of oil as the alternative currencies are likely to be stronger than ours -- and that would increase our oil import bill when measured in dollars.

While there have been a couple of decent months in the deficit figures I wouldn't expect currency changes or the J-curve to bail us out. Investors certainly don't think so either: look at the action in gold, even after allowing for recent profit taking. The markets' message about future improvement in our external accounts is clear: "Not bloody likely!"

Posted by: JB | May 28, 2006 at 04:23 AM

Reading between the lines, I can see that you expect the dollar to fall and that you do not expect the adjustment to be a bumpy one. So I guess I am on your team.

But I think you put the main question poorly. The question is not whether folks might abandon the dollar or "call" a foreign country. The more relevant question is whether foreigners will be willing to ADD to their net long positions in dollar assets at a pace sufficient to finance the widening current account deficit -- at prevailing exchanges rates and international yield differentials.

Answer that question and you mostly have the dollar outlook. But I don't see how the question you raise is more than a red herring. It is neither likely nor necessary to the dollar bear view that international investors abandon the dollar.

Posted by: Gerard MacDonell | May 30, 2006 at 06:17 PM

Gerard -- Indeed, my point is that there is a not-too-high upper bound to the degree to which global savers will desire to reduce their acquisition of dollar assets.

Posted by: Dave Altig | May 30, 2006 at 09:25 PM

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