Thursday, September 27, 2007

A Good Summary of How the US Dollar Has Fared Since the Drop in the Fed Funds Rate

Excerpts below from an article in Bloomberg, gives a good summary of how the dollar has fared since the Fed cut rates. As anticipated in a number of previous posts at this site, a drop in the Fed Funds rate would weaken the dollar over time. If the Fed finds it necessary to continue to drop rates to keep the US economy from sliding into a recession (the likely case) we will continue to see a decline in the dollar. This will do a number of things to the US: 1) US exports will become cheaper, 2) Imports into the US will become more expensive in the US dollars, this includes oil, 3) things in the US will become cheaper, so expect more investment in the US by foreign firms such as the 20% stake in NASDAQ that will be purchased by Middle Eastern interests, 4) the interest in holding US dollars as a reserve currency will decline, 5) interest in buying US Treasury securities (i.e. financing the US debt) outside the US could decline without an interest rate increase, etc. There are probably additional issues that have been missed, but this gives an idea of some of the issues at stake.

The dollar fell to an all-time low against the euro on speculation a government report will show a drop in U.S. home sales, bolstering the Federal Reserve's case for cutting interest rates.

The currency is headed for its biggest quarterly slump versus the yen since December 2004 as the yield advantage for two-year Treasuries over similar-maturity Japanese debt narrowed to the least in almost three weeks. The dollar has weakened against 14 of the 16 most-active currencies since June 30, falling 4.4 percent versus the euro.

``We are most likely to see further downside for the dollar,'' said Adam Cole, head of global currency at Royal Bank of Canada in London. ``If you look at the economic fundamentals of the U.S., there's little to stand in the way of further dollar weakness against other major currencies.''

Against the euro, the dollar fell to $1.4148 at 10:54 a.m. in London, after reaching $1.4166, the lowest since the European currency's January 1999 debut. It traded at $1.4128 in New York yesterday. The U.S. currency was little changed against the yen at 115.62.

The dollar has touched a record against the euro for six straight trading days. Deutsche Bank AG, the world's biggest currency trader, this week forecast the dollar will decline to $1.45 per euro by year-end. (my emphasis)

The euro pared gains against the dollar and yen after the European Central Bank loaned the most to banks today since October 2004, renewing concern about credit-market squeeze. The central bank loaned 3.9 billion euros at its emergency rate. (my emphasis, looks like the credit crunch is not over yet)

The European single currency then recouped some losses on ECB figures showing M3 money supply, which policy makers use to gauge future inflation, held near to a 28-year high in August, adding to the case for higher interest rates.

Futures contracts today showed 86 percent odds the Fed will lower its target overnight lending rate between banks by a quarter-percentage point to 4.50 percent at its next meeting Oct. 31, compared with 80 percent a week ago. The European Central Bank's key rate is 4 percent and the Bank of Japan's is 0.5 percent, the lowest among industrialized countries. (my emphasis, please realize that this value can change very rapidly)

Europe's single currency may strengthen to $1.4500 by year- end, Lee Wai Tuck, strategist at Forecast Singapore Ltd. forecast, citing the prospects of a further shift in interest- rate differentials between the U.S. and the 13-nation region in favor of the euro.

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