Dollar wise

The hand-wringing over the US dollar's fall has been overdone. The greenback is expected to remain weak, but few think declines will accelerate in spite of debates over the dollar's role in the world economy.

Last week the dollar fell to a 14-month low against a basket of six major currencies in part because of concerns about the slow recovery in the US economy.

But the decline in the currency has been orderly and other measures of risk, such as the rally in stocks and low interest rates, suggest a healthy outlook toward US assets and economic growth.

The worries heightened earlier last week when several Asian central banks intervened in the markets to buy dollars to weaken their currencies. Markets were calmed only later after US Federal Reserve chairman Ben Bernanke made comments that supported the greenback.

The dollar is not so very weak from a longer-term perspective, analysts note.

"Everyone thinks the world is ending" because of the drops, said Mike O'Rourke, chief market strategist at BTIG. "But we're still above levels where we spent most of last year."

The dollar index is still more than 7 percent higher against a record low hit in March last year, and more than 8 percent higher than its July 2008 low hit against the euro.

And the action in the forex market has been relatively orderly, with low volatility. One-month realized volatility, a measure of a currency's movements based on underlying prices, was 8.8 on Friday for the dollar index, according to Reuters data, which is 41 percent lower than highs hit in mid- June.

The pattern is the same in the euro's price action versus the dollar. On a three-month rolling basis, realized volatility fell to a 14-month low on Friday. "There's nothing worrisome about the price action to suggest US authorities may need to make a more forceful defense of the currency," said Richard Franulovich, senior currency strategist, at WestPac Securities in New York.


Expectations for future gyrations in the forex market have not spiked either. Implied volatility, which reflects the expectation of discomfort or complacency among investors, has been falling as the dollar dropped. Friday's one-month implied vols in euro/dollar were at 9.9 percent, off their June highs at 16.0 percent.

This suggests that investors expect subdued movements in the euro versus the dollar over the next 30 days.

Still, investors are concerned that sentiment has turned against the dollar. Dollar bearishness has long hovered in the currency market, but that was in part a function of a reversal in the safe-haven bid that made investors flock to the dollar in late 2008 as the financial crisis raged.

Now, after the Reserve Bank of Australia raised benchmark interest rates to 3.25 percent on Tuesday and Canada's employment data on Friday showed a surge in jobs creation for September, concern is developing that other economies are poised to recover more quickly than the United States.

A primary concern for those investing in the United States are growing US deficits. Some see rising interest rates as a threat to the economy because it makes borrowing more expensive, potentially choking off growth.

"The part that's worrying is the rise in Treasury yields. and that US officials are keeping an eye on that," said Steven Englander, head of North American FX strategy at Barclays Capital in New York.

"The last thing they want is for dollar weakness to lead to a Treasury sell-off and premature upward pressure in those rates."

That hasn't happened yet though. Benchmark 10-year Treasury yields on Friday were at a reasonable 3.386 percent compared with about 3.30 at the end of September, and much lower than levels in late June last year when yields hit 4.16 percent.

Worries that investors will shun the world's most liquid government bond market due to a weak economy and growing deficit have not come to fruition. Last week's US Treasury auctions suggested healthy demand for US securities from foreign central banks. The stock market, meanwhile, a less reliable indicator, has been on a tear since March in expectation of renewed demand.

The Obama administration seems to be comfortable with a weaker dollar, analysts said, in spite of repeated rhetoric about the need for a strong US currency.

"It makes sense to let the dollar weaken; it is a global economy so everyone has to see some degree of weakening themselves," said BTIG's O'Rourke.

"If the dollar weakens you get to a more normal trade deficit - some parts of manufacturing come back as it becomes cheaper to produce here and exports would increase."

In the currency market, most are even predicting further declines going forward. Westpac's Franulovich said the dollar's structural flaws - a huge fiscal deficit relative to gross domestic product and record low interest rates - are too overwhelming to ignore.