Everyone agrees that the dollar will keep falling; the dispute is over how long

11/25/2009 12:30 pm EST


Jim Jubak

Founder and Editor, JubakPicks.com

Unemployment. Consumer spending. New home sales. End of the year profit-taking. End of the year portfolio window dressing. All those drive the stock market day to day.

But none pack the wallop that the rising and falling (mostly falling recently) price of the U.S. dollar does. When the dollar falls these days, usually, stocks rise. When the dollar climbs, usually, stocks fall.

Until we can see clear evidence that the U.S. economy is in a sustained economic recovery—or not—I don’t see anything as important to investors as the direction of the dollar.

So what’s the most likely trend on the dollar?

Down, say most of the dollar forecasters recently surveyed by Bloomberg. Although they disagree on how far into 2010 that downward trend will stretch.

The four forecasters that Bloomberg rates most accurate over the 18 months that ended in June 2009 are the most pessimistic.

Standard Chartered (SCBFF), Aletti Gestielle, HSBC (HBC), and Scotia Capital, the four investment companies that Bloomberg rates most accurate on the direction of the dollar to date, say the dollar will continue to fall, even after the Federal Reserve starts to raise interest rates. The U.S. currency will depreciate by as much as 6.4% against the euro in the rest of 2009 and 2010.

History shows, Callum Henderson, the head of foreign-exchange strategy at Standard Chartered, told Bloomberg, that the dollar won’t start rising on a sustained basis until 12 months after the Federal Reserve starts to increase interest rates.

Henderson, the best forecaster of the dollar against the euro in the six quarters that ended in June according to Bloomberg’s rankings, projects that the U.S. dollar will fall 5.3% to $1.58 per euro in 2010 from $1.497 at the time of the his forecast.

He sees the dollar staying weak until U.S. interest rates, now at 0% to 0.25%, rise above interest rates in Japan and Europe. In the case of Japan that’s likely to be easy: The Bank of Japan recently kept its benchmark interest rate at 0.1%. (Factoring in the inflation rates in the United States and Japan, Japan has a lower real rate of interest right now, however.) Europe and the euro will be tougher. The European Central Bank has set its benchmark rate at 1% and will probably start to raise interest rates before the Federal Reserve does.

By the end of 2010, the Bloomberg survey projects, the European Central Bank will have increased its benchmark overnight lending rate to 1.5% while the Federal Reserve will be at 1%.

If that’s correct, the dollar will stay weak against the euro into 2011, if I follow Henderson’s logic correctly.

Most forecasters surveyed by Bloomberg think that’s too pessimistic. The median forecast in the survey has the dollar gaining against the euro, yen, and the other currencies in the U.S. Dollar Index by September 30, 2010. The median projection is for $1.46 to the euro.

The difference in timing is largely a dispute over history. The bulk of forecasters, unlike the four top-rated by Bloomberg, see the U.S. dollar starting to gain strength as soon as the Federal Reserve starts to raise interest rates.

For investors the take away from this dispute is this: for the next six months at least, the dollar is projected to keep falling.

After that the trend for the U.S. currency will depend on when and how fast Federal Reserve moves and how fast the U.S. economy recovers against the economies of the rest of the world.
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