The Mighty Greenback

The dollar took a pounding yesterday as the FOMC opened the monetary spigot full blast. I think the Euro appreciated nearly five cents which is a rare move indeed. I post some excerpts from an FX analyst who believes that the dollar will suffer the slings and arrows of outrageous fortune in the short run. The same analyst believes that a growth story will triumph and the aggressive response of American officials will produce recovery here more quickly than abroad.

That expectation should limit the losses on the dollar. Here is the promised excerpt:

There are two immediate issues for investors. First, is this it or as some observers have claimed is the Fed really all in? We suspect not. This is to say there are additional measures that can be adopted beyond simply increasing the scale of current operations. First, there has already been the official hint that the TALF program could be extended with the eligible collateral expanded to include other financial assets. Second, the Federal Reserve could buy corporate bonds. Thirdly, the Federal Reserve could request authority to issue its own bonds. A fourth course of action could be the plan that some at the FDIC, including the chair Bair, have been pushing. It would be to set up the long talked about aggregator bank (Asset Disposition Facility). The point here is that although the Fed appears to have succeeded in getting ahead of the curve, it is still in the game has not exhausted its options.

The second issue is whether this is a game changer for the dollar. We don’t think so. Our big macro-view was that the de-leveraging/leveraging axis which we believe has been the big driver of the foreign exchange market would fade and be replaced by a return of anticipated growth trajectories. We expected the dollar to wobble in a transition phase. The euro had already moved 5 cents from the lower end of its recent range to the upper end prior to the Fed’s move. It advanced another 5 cents yesterday. Ahead of the end of the month/quarter/ fiscal year, amid portfolio adjustments, we see scope for another 5 cents toward $1.40. We see room for sterling to rise toward $1.4450 or so. Against the yen, the dollar can slip to the mid-JPY94 area. However, over the slightly longer-term, we continue to believe that the aggressiveness of the US policy response dramatic inventory correction will be rewarded with an earlier recovery than in Europe and Japan. The EU 2-day EU summit that begins today will likely see officials dig in their heels and reject calls for greater stimulus, highlighting the contrast. Even though the US downturn is not as steep as Europe’s the US fiscal stimulus is estimated at 5.9% of GDP, compared with 3.4% in German, 1.5% in the UK, and less than 1% in France and less than 0.5% in Italy.

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