Dollar Sole Refuge as Traders Have ‘No Alternatives’

By Matthew Brown and Kim-Mai Cutler

Feb. 27 (Bloomberg) -- The dollar is approaching a three- year high against the currencies of major U.S. trading partners as the plunge in the yen and Swiss franc leaves the world’s reserve currency the only refuge from economic turmoil.

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, even after a 0.9 percent gain today. 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 ICE’s Dollar Index, which tracks the U.S. currency versus the euro, yen, pound, franc, Canadian dollar and Swedish krona, increased 8 percent to 87.80 in 2009 as investors sought safety from the deepening global recession. The measure rose to 88.463 on Nov. 21, the highest level since April 2006.

The yen climbed to 97.68 per dollar as of 7 a.m. in New York today, from 98.52, paring this month’s drop to 7.9 percent, as exporters brought home earnings before closing their books for the end of the month.

Dollar Forecasts

Currency forecasters estimate the dollar will be little changed at $1.28 per euro and 97 yen by the end of the year as policy makers attempt to lift the global economy from recession. The franc will weaken to 1.17 against the dollar in that period, according to the weighted average of estimates from forecasts surveyed by Bloomberg.

The franc dropped 8.3 percent against the dollar in 2009 after gaining 6 percent versus last year. The correlation between the franc, as traded against the euro, and gold, which is traditionally bought as a haven investment, dropped to minus 0.04 from 0.73 on Dec. 4.

Japan’s currency gained 23 percent in 2008 as the yen was the biggest beneficiary of the financial crisis and a plunge in stocks. Demand for the yen as a haven eroded as Japanese reports showed gross domestic product contracted in the fourth quarter by 12.7 percent, the biggest annual pace since the 1974 oil shock, and exports plunged in January.

Carry Trades

The yen has suffered as carry trades finished unwinding, according to Henrik Gullberg, a foreign-exchange strategist in London at Deutsche Bank AG, the world’s largest currency trader. In such a trade, higher-yielding currencies are bought with lower yielders, such as the yen. The currency will weaken to a range of 105 to 110 versus the dollar within three months, Gullberg said. Japan’s target lending rate of 0.1 percent is among the lowest in the world.

“The entrenched view that still places the franc as a very defensive currency is now being questioned more widely,” said David Bloom, global head of currency strategy in London at HSBC Holdings Plc. “In a political crisis it may still have excellent defensive qualities, but in a financial crisis led by the banks, it most certainly does not.”

UBS, Switzerland’s largest bank by assets, suffered more than $50 billion in writedowns from the global financial crisis, as well as a U.S. probe in connection with tax evasion by wealthy Americans. Zurich-based UBS hired Oswald Gruebel yesterday to replace Marcel Rohner as chief executive officer, tapping the veteran banker who turned around Credit Suisse Group AG, to restore investor confidence.

Lower Rates

The euro dropped 8.9 percent against dollar this year on concern financial turmoil in Europe will worsen, supporting the case for policy makers to lower interest rates. The International Monetary Fund already predicts the euro-region economy will contract 2 percent this year and IMF Managing Director Dominique Strauss-Kahn said Feb 19 that the forecast may need to be cut.

The greenback will be boosted by demand from central banks, said Michael Klawitter, a currency strategist at Dresdner Kleinwort in Frankfurt, citing a 2 1/2-year high in bidding from a group including overseas investors at the record $32 billion sale of five-year Treasuries on Feb. 25.

“The dollar’s safe-haven status plus its role as a reserve currency are the two factors that are making it currently more attractive than the euro and the yen,” said Klawitter, who forecasts the dollar will strengthen to 105 yen by year-end.

The Federal Reserve enabled the European Central Bank, the Bank of England and the Swiss National Bank to offer unlimited dollar loans through swap lines in October. The Fed agreed a month later to pump $120 billion into Brazil, Mexico, South Korea and Singapore through additional swap lines to help unlock lending in emerging markets.

Dollar Funding

Outside the 13 central banks being provided funding by the Fed, the need for dollar-based funding remains strong. Indonesia proposed a currency-swap accord with the U.S. to help bolster the rupiah, during Secretary of State Hillary Clinton’s visit to Jakarta last week.

U.S. President Barack Obama’s proposed budget forecasts outlays for the current fiscal year of $3.94 trillion, up 32 percent from a year ago. That would result in a record deficit of $1.75 trillion in the year ending Sept. 30, equal to about 12 percent of the nation’s gross domestic product, the highest since World War II.

“In the longer term, the vast external liabilities of the U.S. economy argue for a weaker dollar,” said Axel Botte, a strategist at Paris-based AXA Investment Managers, which has about $800 billion under management. “In the near term, the dollar is the one currency that can rise.”

To contact the reporters on this story: Matthew Brown in London at mbrown42@bloomberg.net; Kim-Mai Cutler in London at kcutler@bloomberg.net