By Oliver Biggadike
March 23 (Bloomberg) -- Less than a month after lambasting European Central Bank President Jean-Claude Trichet for failing to keep up with Ben S. Bernanke’s efforts to stem the recession, foreign-exchange traders are glad he’s behind the curve.
The 16-nation currency strengthened 7.5 percent versus the dollar since February, after tumbling 9.3 percent in the first two months of the year. JPMorgan Chase & Co., Morgan Stanley and Citigroup Inc. are advising investors to buy euros.
Traders are looking past forecasts from Germany’s Kiel- based IfW institute for the European Union economy to shrink 3.3 percent this year, and snapping up currencies where central bankers are resisting calls to purchase debt securities as a way of lowering interest rates and pump cash into their financial systems. Those options are becoming scarce after Federal Reserve Chairman Bernanke joined the Bank of England, Bank of Japan and Swiss National Bank in so-called quantitative easing.
“The dollar is a sell near term versus those currencies where quantitative easing is off the table,” said John Normand, head of currency strategy at JPMorgan in London. “The top on euro-dollar will come when the ECB looks likely to join the quantitative easing crowd. For now, it’s content to stay on the sidelines.”
The euro will probably rise 2.8 percent to $1.40 in a month after soaring 5.1 percent last week as long as the ECB refrains from purchasing assets, Normand predicted. The Euro Index, which tracks the currency against the dollar, pound, yen, Swiss franc and Swedish krona, climbed 2.6 percent to 118.03. The euro gained 0.4 percent today to $1.3630 as of 9:41 a.m. in Tokyo.
Fed Spending
The Fed said March 18 that it plans to expand its balance sheet by as much as $1.15 trillion as it buys up to $300 billion of U.S. government bonds and steps up purchases of mortgage securities. Bernanke’s goal is to reduce consumer borrowing rates such as those for mortgages and encourage banks to lend in an effort to boost the economy.
The trade-weighted Dollar Index, measured against the euro, yen, pound, Canadian dollar, Swiss franc and Swedish krona, posted its biggest one-day drop since 1971, tumbling 2.69 percent, and fell 4.1 percent for the week to 83.841.
“This is a historic moment -- the start of debasement of the world’s reserve currency,” wrote Alan Ruskin, head of international currency strategy in North America at RBS Greenwich Capital Markets Inc. in Greenwich, Connecticut. “It feels to many participants that in the grand sweep of history we are witnessing the end of ‘Rome’ on the Potomac.”
Shrinking Economy
U.S. gross domestic product shrank 6.2 percent last quarter, the most since 1982. The Congressional Budget Office said March 20 that President Barack Obama’s administration will generate a budget deficit of $1.85 trillion this year, and expenses will exceed revenue by a total $9.27 trillion between 2010 and 2019. That’s about $2.3 trillion more than the administration forecast. At 8.1 percent, the unemployment rate is the highest in more than a quarter century.
The flood of dollars also increases the chances for quicker inflation in the global economy, spurring demand for commodities and currencies of raw materials producers. The Standard & Poor’s GSCI Index of commodities is up 21 percent since Feb. 18 to 372.1680, and last week posted its biggest gain in two months, rising 8.6 percent.
“Quantitative easing across the board will diminish the fiat currencies as a store of value,” said Lee Hardman, a foreign-exchange strategist at Bank of Tokyo-Mitsubishi UFJ Ltd. in London. “Investors may then seek refuge in harder currencies such as commodities.”
BHP’s Gain
Hardman recommends Norway’s krone, the Australian dollar and New Zealand dollar. Demand for Australian coal, iron ore and wool drove 17 consecutive years of economic expansion. Norway is the world’s fifth-largest oil producer and New Zealand relies on sales of milk powder, butter, cheese and aluminum.
Australia’s dollar climbed 4.4 percent last week to 68.69 U.S. cents, while the krone rallied 6.5 percent to 6.3773, the biggest gain since 1973 and the most among the 16 most-traded currencies. New Zealand’s dollar appreciated 6.4 percent to 55.87 U.S. cents. Melbourne-based BHP Billiton Ltd., the world’s largest mining company, climbed 1.6 percent to A$32.18 on the Australian stock exchange.
Trichet, 66, took over the ECB from the Netherlands’ Wim Duisenberg in November 2003. Under his watch, the euro appreciated to a peak of $1.6038 in July 2008 from about $1.15.
The currency began to slide as the ECB waited until October 2008 to cut interest rates as the global economy slowed, more than a year after Bernanke began slashing borrowing costs. The ECB’s main rate is 1.5 percent, compared with a target range of zero to 0.25 percent for the Fed.
‘Behind the Curve’
A drop in two-year German bund yields in February to the lowest relative to longer-maturity debt since 1997 was a sign that the ECB needs “to wake up to reality,” Komal Sri-Kumar, chief global strategist at Los Angeles-based TCW Asset Management, which oversees about $118 billion, said last month.
“European policy makers are behind the curve,” said Neil Mackinnon, chief economist and partner at ECU Group, a London- based hedge fund with about $1 billion in assets. “The European economy will sink deeper into depression.”
While the ECB has refrained from quantitative easing, the European Union has taken other steps to bolster the economy. EU leaders said March 20 that they will double to 50 billion euros ($68 billion) a credit line for countries in financial distress.
Even Mackinnon says the euro rally may be short-lived as the ECB cuts its main refinancing rate close to zero. He expects the currency to depreciate to $1.245. None of the 53 analysts surveyed by Bloomberg forecast the currency will return to its previous high of $1.6038.
Sufficient Strategy
“All major central banks will have to follow the Fed and adopt quantitative easing,” said Mackinnon, a former economist for the U.K. Treasury. “If the European policy makers are hoping they will get a free ride on the U.S. stimulus, hoping they will look more prudent, they are deluding themselves.”
Trichet said March 17 in a speech to business leaders in Paris that his policy of loaning banks unlimited funds is sufficient for now.
“In the context of the euro area, guaranteeing firms and households a steady access to credit largely means ensuring the banking system has appropriate liquidity,” Trichet said. “In the euro area, it is natural for ‘credit easing’ to be implemented primarily through the participation of banks.”
In a March 19 report titled ‘Sprint to Print,’ Morgan Stanley recommended selling the dollar against the euro, forecasting it will depreciate to $1.45 in a year.
‘Turning Point’
“This move may mark the turning point for the dollar,” wrote Morgan Stanley currency analysts led by Sophia Drossos and Ron Leven in New York. “The Fed’s action exposes the dollar to its vulnerabilities, but this leaves the euro and the yen facing appreciation.”
Citigroup’s London-based global head of currencies, Jim McCormick, said in a research report to clients last week that the euro may rise to $1.40. “We’ve been selling dollars and we’re now adding to that short,” he wrote in the report.
Samarjit Shankar, a director of strategy for the global markets group in Boston at Bank of New York Mellon, which administers more than $23 trillion, also predicts $1.40.
“You have Bernanke taking a page from Greenspan’s book and reflating assets,” said Shankar. Former Fed Chairman Alan Greenspan cut interest rates to 1 percent in 2003, the lowest level since World War II, to boost growth after the 2001 recession. The ECB takes “a very orthodox, almost straitjacketed approach,” he said.
Buying Euro Calls
Werner Eppacher, head of foreign exchange at Deutsche Bank AG´s DWS Investment unit in Frankfurt, said he bought call options on the euro versus the dollar and used forwards to bet on the common currency gaining versus the greenback.
Calls give the buyer the right to purchase an asset at a predetermined price, and forwards are agreements to trade a currency pair in the future.
“The U.S. is facing more structural problems than other regions,” Eppacher said. “As soon as we have some moderation in financial markets, the conversation will go back to U.S. households deleveraging and external deficits, fiscal deficits, money printing.”
He predicts the euro will rise to $1.40 in six months, and the Australian dollar will appreciate to 75 U.S. cents.
“The euro is not rising on its own merits,” said Hans- Guenter Redeker, the London-based global head of currency strategy at BNP Paribas SA, France’s biggest bank. “The U.S. is exporting its expansionary monetary conditions abroad, which ultimately is very positive for equity markers and is going to be very positive for risk takers.”
To contact the reporter on this story: Oliver Biggadike in New York at obiggadike@bloomberg.net.
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