Dollar Regains Haven Status as Deutsche Bank Says Buy

By Agnes Lovasz

Oct. 27 (Bloomberg) -- The dollar is reasserting its status as the world's reserve currency as investors seek a haven from plunging emerging-market stocks and bonds.

The ICE futures exchange's U.S. Dollar Index, which tracks the greenback against six trading partners, rose last week the most in more than four decades as the dollar soared to a two- year high versus the euro and reached its strongest in six years against the U.K. pound. A global grab for dollars has pushed the index up 22 percent since July 15 to the highest since April 2006.

The sell-off in emerging markets may ``set the stage'' for bigger gains, says Barclays Capital in London. Demand for the safety of Treasuries is turning the foreign-exchange market into a ``one-way street,'' according to Frankfurt-based Deutsche Bank AG, the world's biggest currency trader. BNP Paribas SA, the most-accurate forecaster in a 2007 Bloomberg survey, says the dollar may return to parity with the euro in coming months.

The global crisis ``is manifesting into dollar strength,'' said Hans-Guenter Redeker, the London-based global head of currency strategy at BNP Paribas.

Last week the Dollar Index surged 4.9 percent to 86.44, as the greenback climbed 5.9 percent to $1.2623 per euro and strengthened 8 percent to $1.5897 to the pound. Its biggest gain came against the Australia dollar, rising 11.6 percent, followed by a 10.7 percent increase versus the New Zealand dollar and an 8.8 percent advance versus the South Africa rand.

Crisis Intensifies

Investors, banks and even companies are scooping up dollars to repay loans denominated in the currency as the 14-month-long credit crisis intensifies.

Banks have extended about $2.5 trillion in foreign-currency loans to emerging markets, according to Barclays, which cited data compiled by the Bank for International Settlements in Basel, Switzerland. Some 70 percent of the claims on developing nations in Asia mature in less than one year, while the amount for emerging European countries is 43 percent.

``Deleveraging, which has been going on in developed countries for at least 12 months, has just begun in the developing world,'' a Barclays team led by London-based David Woo wrote in an Oct. 23 report. ``The increasing difficulty facing developing countries to roll over their foreign-currency loans may set the stage for even greater strengthening of the dollar.''

Emerging Markets Tumble

Yields on emerging-market dollar-denominated bonds climbed to 8.62 percentage points more than Treasuries last week as investors dumped the securities, up from 3 percentage points at the start of September, according to the JPMorgan Chase & Co. EMBI+ Index. The MSCI Emerging Markets Index fell to a five-year low as stocks from Brazil to Korea tumbled on speculation developing nations will find it harder to service foreign debt.

Demand for dollars can be seen in the Treasury market, where the Federal Reserve's holdings of U.S. government debt on behalf of foreign central banks and institutions have increased by $60.1 billion this month to $1.56 trillion. That's the biggest monthly gain on record.

``Combined with rapid dollar repatriation and U.S. banks having grown increasingly reluctant to lend dollars to banks abroad, this has generated a sustained demand for dollars,'' a Deutsche Bank team led by Bilal Hafeez, global head of currency strategy in London, wrote in an Oct. 24 report.

Dollar Questioned

When the euro was rallying 38 percent from November 2005 through July, economists said the dollar was in danger of losing its primacy. The euro's share of global central bank reserves rose to 27 percent at the end of March from 17 percent in 2000, according to the International Monetary Fund in Washington. The dollar's share fell to 62.5 percent from 72.1 percent.

As recently as April, the National Bureau of Economic Research, the group that determines when recessions begin and end, said the euro may become the world's reserve currency in the next seven years. Jeffrey Garten, a professor of international trade at the Yale School of Management in New Haven, Connecticut, and undersecretary for commerce and international trade in the Clinton administration, said in November the world was undergoing a ``rebalancing'' of economic power.

The prospect of falling U.S. interest rates may offset some of the demand for the dollar. The odds on the Fed halving its target rate for overnight bank loans to 0.75 percent on Oct. 29 rose to 26 percent last week, futures on the Chicago Board of Trade showed. The chances were zero a week earlier.

Dollar `Pullback'

The U.S. already has the lowest rates of any Group of Seven industrialized nation except Japan, where the key rate is 0.5 percent. That means even dollar bulls expect the gains may slow before picking up again later in the year or in 2009.

``We will look for a pullback,'' said Meg Browne, vice president of foreign-exchange research at Brown Brothers Harriman & Co. in New York. Still, ``we haven't ended this period of unwinding'' and over the next two to three years ``the dollar will strengthen,'' she said.

Another obstacle for the dollar is the flood of debt the U.S. will sell to finance the budget deficit and bank bailouts. Gross issuance of Treasury coupon securities will rise to about $1.15 trillion in the 2009 fiscal year from $724 billion last year, according to Credit Suisse Securities USA LLC, one of the 17 primary dealers of U.S. government securities obligated to bid at Treasury auctions.

``The true test whether the dollar really is a safe haven has yet to come,'' Deutsche Bank's London-based currency strategist Henrik Gullberg wrote in an Oct. 24 report to clients.

Commodity Currencies

A survey dated Oct. 27 of 30 fund managers overseeing $1.45 trillion by Jersey City, New Jersey-based Ried Thunberg & Co. found that 59 percent expect the dollar to strengthen against the euro over the next three months, down from 71 percent last week.

As the dollar gains, the currencies of commodity-exporting nations including Australia and Canada are likely to suffer most, according to Citigroup Inc. The Australian currency has dropped 23 percent versus the greenback in the past month, while Canada's dollar has slumped 19 percent as commodities tumbled.

``Dollar repatriation overtakes coordinated policy action at the heart of the radar,'' analysts led by London-based Tom Fitzpatrick, global head of currency strategy at Citigroup, wrote in a report Oct. 24. ``Capitulation on long positions in foreign assets is gaining pace. Risk reduction should continue to dominate. Commodity currencies should suffer the most.''

Morgan Stanley recommends currencies in countries with low interest rates, such as Japan and the U.S., where investors sought loans to purchase assets in countries with higher rates.

Foreign exchange ``market dynamics suggest the frictions are not over yet,'' Sophia Drossos, a currency strategist at Morgan Stanley in New York, said in an Oct. 22 report to clients. ``Flows appear consistent with continued delivering and we expect this trend has further to run.''

To contact the reporter on this story: Agnes Lovasz in London at alovasz@bloomberg.net