Dollar Bears' Mea Culpa Makes Bernanke No Liability

By Bo Nielsen and Ye Xie
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Sept. 2 (Bloomberg) -- Federal Reserve Chairman Ben S. Bernanke has gone from a dollar liability to an asset, sparking a rally that even bears say shows few signs of ending.

While the U.S. Dollar Index fell to a record low in March as the Fed cut interest rates at the fastest pace in two decades, traders now anticipate lower borrowing costs will help America recover from a global economic slowdown before Asia or Europe. Investors bought four times as many dollars in August as the average over the previous 12 months, according to Bank of New York Mellon, a custodian for more than $23 trillion in assets.

Traders who a month ago doubted there was anything Bernanke could do to keep the greenback from depreciating in the face of a widening budget deficit, mounting credit market losses and falling consumer confidence are embracing the currency. The 6.4 percent gain against the euro in August was the best monthly advance since Europe's common currency was introduced in 1999. Futures traders are making the biggest bets on the dollar versus six major trading partners since 2005.

``The dollar is cheap,'' said Roddy MacPherson, an Edinburgh-based fund manager at Scottish Widows Investment Partnership Ltd., which manages about $165 billion. ``The U.S. has been quite preemptive in bringing rates down and that bodes better for the U.S. relative to many other countries.''


MacPherson set up trades to profit from the U.S. currency's appreciation against the Group of 10 countries, which include the U.K., Japan and Australia, after it hit a record-low of $1.6038 to the euro on July 15.

Six-Year Plunge

Last month's rally to $1.4672 per euro followed a six-year, 75 percent decline as the U.S. current account deficit swelled to a record $788 billion, the economy posted its slowest growth since 2001 and the subprime mortgage market collapsed, costing the world's biggest financial companies more than $500 billion in losses and writedowns.

The resurgence caught strategists off guard. New York-based Goldman Sachs Group Inc. on Aug. 14 scrapped its call predicting the dollar would weaken to $1.60 per euro in six months and said the currency had ``bottomed.'' Morgan Stanley, also in New York, flipped its forecast last week, and now expects it to trade at $1.48 by the end of the month and gain to $1.40 by year-end. The firm had estimated $1.60 in September and $1.53 in December.

The dollar advanced against the euro for a fourth straight day today, rising to $1.4495 as of 9:14 a.m. in London, from $1.4617 yesterday and $1.4673 at the start of the week.

Cheaper Goods

``Like many in the market, I was surprised by the magnitude of the dollar move, but it just seems to keep going,'' said Stephen Jen, the London-based head of foreign-exchange research at Morgan Stanley. ``It's not that the U.S. economy is doing better, it's that everyone else is doing worse.''

The dollar's slide made U.S. goods and assets cheaper abroad. The Commerce Department said Aug. 28 that the economy expanded at a 3.3 percent annual rate in the second quarter, compared with 0.9 percent in the first three months. The increase was helped by the narrowest trade deficit in eight years.

Growth in the euro region will slow to 1.5 percent this year and 1.1 percent in 2009 from 2.7 percent in 2007, according to the median forecast in a Bloomberg survey of economists. Japan's expansion will ease to 1.1 percent this year and 1.2 percent in 2009, from 2.08 percent in 2007. The U.S. will grow 1.5 percent in 2008 and maintain that pace in 2009, the survey shows.

Dollar Bears

``All of a sudden, the gamble the Federal Reserve made last year and in the early parts of this year cutting interest rates looks like a very smart move,'' Simon Derrick, chief currency strategist at Bank of New York Mellon in London, said in an interview on Bloomberg Television. ``At 2 percent, it's very well positioned to support growth. The dollar still looks incredibly cheap.''

Bernanke slashed the Fed's target rate for overnight loans between banks seven times from 5.25 percent in September through April as contagion from subprime loans caused credit markets to freeze. The U.S. Dollar Index, which tracks the dollar against major currencies including the euro, yen and pound, fell 8.6 percent in that period.

The European Central Bank, meanwhile, left its benchmark rate at a seven-year high of 4.25 percent last month.

The rally stiffened the resolve of bears such as Maxime Tessier, head of foreign exchange at Caisse de Depot et Placement du Quebec, a Montreal-based pension fund that manages about $258 billion.

The U.S. recession ``will be bigger than most people seem to be anticipating,'' Tessier said. ``That will force the Fed to start cutting interest rates again.''

`A Lot of Hope'

Tessier set up trades last month to profit from a decline against the euro, Scandinavian currencies and the Swiss franc. The dollar has already strengthened beyond the $1.48-per-euro consensus estimate of 36 analysts and strategists in a Bloomberg survey.

``There is a lot of hope that the dollar increases in value but there seems to be no U.S. policy that invokes a strong dollar,'' said Tom Sowanick, who helps manage $22 billion as chief investment officer at Clearbrook Financial LLC in Princeton, New Jersey.

While the gains may slow before year-end, the median forecast is for it to finish 2009 at $1.38 per euro.

The rally picked up steam on Aug. 7 after ECB President Jean-Claude Trichet said growth in the euro-zone will be ``particularly weak'' through the third quarter, a sign policy makers are reluctant to raise rates to curb inflation.

Lehman Call

The dollar appreciated against the 16 most-widely traded currencies last month, ranging from a gain of 1.45 percent versus the yen to 8.47 percent compared with the Australian dollar.

Futures traders boosted the value of contracts profiting from a rise in the dollar to $16.6 billion more than those benefiting from a loss as of Aug. 19, the most since November, 2005, according to Bank of America Corp.

``There's a sense the market is voting with its feet and buying U.S. assets,'' Steven Englander, a strategist at Lehman Brothers Holdings Inc. in New York, said in a Bloomberg Television interview. Lehman became bullish on the dollar as early as March this year, according to Jim McCormick, the firm's London-based global head of foreign-exchange strategy. The currency will strengthen to $1.40 per euro by March, Lehman says.

To contact the reporters on this story: Bo Nielsen in Copenhagen at bnielsen4@bloomberg.net; Ye Xie in New York at yxie6@bloomberg.net