Dollar Rises as Citigroup, U.S. Economy Stoke Demand for Safety

By Ye Xie and Matthew Brown

Feb. 27 (Bloomberg) -- The dollar climbed against the euro and pound as investors sought refuge after the U.S. government agreed to a third rescue of Citigroup Inc. and said the economy shrank at a rate higher than previously estimated.

A gauge tracking the greenback against the currencies of six major U.S. trading partners reached the highest level since April 2006. The Hungarian forint and Polish zloty rose against the euro on speculation international aid packages will bolster Eastern Europe’s banking system. The pound fell as consumer confidence held near the lowest level in 30 years.

The dollar strengthened 0.9 percent to $1.2626 per euro at 8:41 a.m. in New York, from $1.2744 yesterday, and gained 1.3 percent to $1.4136 per pound from $1.4317. The U.S. currency decreased 1.6 percent to 96.93 yen from 98.52, paring its monthly gain to 8.6 percent. The euro dropped 2.6 percent to 122.25 yen from 125.52.

The ICE’s Dollar Index, which tracks the U.S. currency versus the euro, yen, pound, franc, Canadian dollar and Swedish krona, reached 88.489, the highest level since April 2006.

The MSCI World Index dropped for a third day, sliding 0.7 percent, while Standard & Poor’s 500 Index futures expiring in March fell 1.5 percent.

Gross domestic product contracted at a 6.2 percent annual pace from October through December, the Commerce Department reported today in Washington. The government estimated that the economy shrank 3.8 percent in its advance report issued last month.

Citigroup Bailout

The Citigroup plan will involve the Treasury Department converting as much as $25 billion of preferred shares into common stock, the Treasury Department said in a statement today. The government will make the swaps only if private holders agree to the same terms. The U.S. doesn’t immediately intend to inject additional money after channeling $45 billion to the New York- based company last year.

Hungary’s forint strengthened as much as 1.6 percent versus the dollar, the Polish zloty appreciated as much as 0.8 percent and the Czech koruna rose as much as 0.6 percent after the World Bank, the European Bank for Reconstruction and Development and the European Investment Bank earmarked about $31 billion to help central and east European banks and businesses cope with the financial crisis.

The dollar will strengthen to $1.23 per euro within a month, Barclays Plc said, revising a previous forecast that anticipated a decline for the U.S. currency.

Debt Yield Spread

Higher Treasury yields relative to German government bonds will stoke the U.S. currency’s gains before it weakens again on concern borrowing is ballooning, David Woo, global head of foreign-exchange strategy in London at Barclays, wrote in a note today. Barclays kept its year-end forecast of $1.45 per euro.

The difference in yield, or spread, between German and U.S. 10-year government notes narrowed to 12 basis points, or 0.12 percentage point, today, near the least since November.

“There is a compelling case to be made that Treasuries should underperform euro-zone government bonds in the near term,” Woo wrote. “The dollar’s strength will prove unsustainable and we expect it to come under renewed selling pressures in the second half of the year.”

The plunge in the yen and Swiss franc has left the dollar, the world’s leading reserve currency, as the only refuge from the economic turmoil, according to the world’s biggest foreign- exchange traders.

Japan’s Economy

Japan’s crumbling economy combined with an end to the unwinding of the carry trade weakened the yen, last year’s best performing currency, by 7.2 percent this year. The franc suffered from a deteriorating Swiss financial system and threats of intervention by the central bank to push the currency lower against the euro.

“There are no alternatives to the dollar right now,” said Geoffrey Yu, London-based strategist at UBS AG, the world’s second-biggest currency trader. “Investors see the rest of the world collapsing, and the yen is no longer a safe haven.”

The yen rose today after its relative strength index, a technical chart used by traders to indicate changes in price direction, dropped to 23.270 yesterday, the lowest level since 2004. The index climbed to 29.905 today. A reading below 30 typically indicates that an asset price may rise.

The pound weakened against the dollar and the euro after a GfK NOP index showed U.K. consumer confidence stayed near a three-decade low, GfK NOP said today.

In a separate survey, GfK NOP said more than 40 percent of British mortgage holders may see their loans exceed the value of their homes by year-end. Bank of England policy maker David Blanchflower said this week the recession will probably deepen “significantly.” The U.K.’s FTSE 350 Banks Index fell 7.3 percent today, the most in two weeks.

To contact the reporters on this story: Ye Xie in New York at yxie6@bloomberg.net; Matthew Brown in London at mbrown42@bloomberg.net