Dollar Strength Seen in Stocks 1st Since Lehman Died

By Matthew Brown and Ye Xie

Dec. 21 (Bloomberg) -- The dollar is rallying in tandem with stocks and commodities for the first time since before Lehman Brothers Holdings Inc.’s bankruptcy last year sparked the financial crisis, signaling the worst may be over for the greenback.

The currency, equities and raw materials are on pace for their first simultaneous two-month gain since 2008 as the U.S. Dollar Index rises the fastest in 10 months. The gauge has moved in the opposite direction of either the Standard & Poor’s 500 Index or the Reuters/Jefferies CRB Index of commodities for 15 months straight and diverged from both in all but four.

Correlated trading reflects growing confidence in the U.S. economy and increasing expectations that the Federal Reserve will start draining some of the $12 trillion used to battle the worst global recession since World War II. Until now, the dollar climbed when traders sought protection from turmoil created by the credit freeze that started in 2007. It weakened when they took advantage of record-low interest rates by selling the currency to finance holdings of higher-yielding overseas assets.

The market’s “tremendous dollar-negative sentiment” is “being corrected,” said Adnan Akant, who helps oversee $39 billion and reversed bets against the currency two weeks ago as head of foreign exchange in New York at Fischer Francis Trees & Watts. “The regime is changing, definitely.”

The Dollar Index -- which measures its performance against the euro, yen, pound, Canadian dollar, Swiss franc and Swedish krona -- dropped 4.5 percent this year. Its tendency to fall when stocks rise and vice versa, which has prevailed since Lehman’s September 2008 collapse, is breaking down. Until Dec. 1, stocks and the Intercontinental Exchange Inc. currency gauge moved in opposite directions on seven of every 10 days this year. They’re in sync more than half the time this month.

Gaining Gauge

With eight trading days left in the year, the gauge has gained 1.8 percent since the end of October, while the S&P 500 and the CRB Index added 6.4 percent and 2.1 percent, respectively. The last time all rose in a two-month period was April and May of 2008. The three indexes, which haven’t all increased in the same quarter since 2005, also are up since Sept. 30.

Currency strategists are growing less bearish on America’s legal tender versus the euro, predicting it will fall 1.1 percent next year to $1.45, up from Nov. 30’s weaker $1.48 forecast, median estimates of as many as 47 in Bloomberg surveys show. It will rise 8.6 percent against the yen, the median of 42 estimates shows.

The Dollar Index rose 1.6 percent last week. Its 4.9 percent rise from this year’s Nov. 26 low is the steepest since a 17-day climb ending Feb. 2.

Dollar, Yen, Euro

Last week, the dollar gained 1.6 percent against Japan’s currency to 90.49 yen and 1.9 percent versus the euro to $1.4338. It traded at 90.52 yen and $1.4356 per euro as of 7:44 a.m. in New York. The greenback is little changed against the yen this year and up 6.4 percent from its 14-year low on Nov. 27. The dollar is still down 2.6 percent compared with the euro in 2009, though it strengthened 5.5 percent since Nov. 25.

Euro speculators reversed course after having more bets on dollar losses than gains for seven months, Commodity Futures Trading Commission data compiled by Bloomberg show. Wagers by hedge funds and other large speculators that the dollar will gain against the euro outnumbered bearish bets by 16,448 on Dec. 15. On Dec. 1, bearish dollar contracts were ahead by 22,151, a sentiment that had prevailed since April 28.

U.S. Economy

News that the U.S. unemployment rate had fallen the most in three years pushed the Dollar Index up 1.7 percent on Dec. 4 as traders increased bets that economic growth would spur the Federal Reserve to raise borrowing costs. That was the biggest gain since Jan. 20, when the U.K.’s second bank bailout in three months increased demand for the dollar’s perceived safety.

“We are witnessing a watershed shift in sentiment regarding the dollar,” wrote Dennis Gartman in the Gartman Letter, a daily global markets commentary he publishes from Suffolk, Virginia. “We do not use the term watershed often, but when we do we mean it,” said Gartman, who correctly predicted in June 2008 that commodities would tumble.

The Fed is already taking steps to begin withdrawing money from the financial system. Policymakers will end most emergency lending programs and debt purchases by March because of “improvements in the functioning of financial markets” and stabilizing labor markets, the Federal Open Market Committee said on Dec. 16. At the same time, the central bank reiterated that interest rates will stay “exceptionally low” for an “extended period.”

Fed Drains

The Fed began using Treasuries and agency debt in reverse repurchase agreements this month to test a mechanism for unwinding unprecedented monetary stimulus, removing a total of $990 million in cash from the banking system in five operations since Dec. 3, data from the Federal Reserve Bank of New York show.

“The forex market will anticipate the Fed tightening and price it into the dollar, leading the dollar to rally,” said Steven Englander, chief U.S. currency strategist in New York for Barclays Capital. “Because these programs are so unprecedented, you can already see a high degree of alarm in markets with respect to what the rates implications are going to be when they are withdrawn.”

The unit of London-based Barclays Plc raised its three- month forecast for the dollar against the euro on Dec. 10 to $1.45 from $1.52 and its six-month prediction to $1.40 from $1.45.

Higher Yields

Investors are being drawn to the dollar by U.S. assets that have higher yields than in Japan and Europe. Ten-year Treasuries yielded 40 basis points, or 0.40 percentage point, more than German bunds as of Dec. 18, within 1 basis point of the biggest gap since August 2007. Investment-grade corporate bonds in the U.S. yielded an average of about 4.67 percent, compared with 3.78 percent in Europe and 1 percent in Japan, Merrill Lynch & Co. indexes show.

“The U.S. will be able to attract more capital than its peers in the developed world” for the next couple years, said Mark Farrington who manages $5.8 billion as head of currencies at Principal Global Investors Europe Ltd. in London. “The dollar appreciation will accelerate,” he said, predicting $1.25 per euro in 18 months and 105 yen in 2010.

Thanos Papasavvas, who helps manage more than $5 billion in currencies at Investec Asset Management in London, said the dollar’s strength against the euro is likely to end amid speculation on the timing of interest-rate increases by the European Central Bank.

‘Sell Dollars’

“There is a risk that the ECB could tighten monetary policy before the Fed,” Papasavvas said, predicting the euro will drop no lower than $1.38 before rising back towards $1.50 in the second half of 2010. “Foreign-exchange managers will be looking for opportunities to sell dollars.”

The Fed will raise its near-zero target rate by more than half a percentage point to 0.75 percent next year, while the European Central Bank will increase its rate to 1.5 percent from 1 percent, according median economist forecasts compiled by Bloomberg. Japan’s rate will stay at 0.1 percent, the survey shows.

The cost of hedging against a dollar rise versus the euro increased to the most in more than a year Dec. 17, so-called three-month 25 delta risk reversals show, an indication that options traders are more certain that it will appreciate. The cost of the right to buy the greenback versus the euro exceeded that for options to sell it by 1.80 percentage points.

PowerShares

The PowerShares DB US Dollar Index Bullish Fund ran out of shares on Dec. 18, and trading was halted for the second time in two months. The fund suspended issuing the 200,000-share blocks it uses to match demand for the exchange-traded fund, which is designed to replicate ownership of the dollar versus currencies measured by ICE’s Dollar Index, according to a filing with the U.S. Securities and Exchange Commission.

The dollar is also appreciating against the euro as investors focus on Europe’s economy. Standard & Poor’s and Fitch Ratings downgraded Greece and warned that Spain and Portugal also may have their credit rankings cut. U.S. gross domestic product will expand 2.6 percent in 2010, twice as fast as in the European Union, U.K. and Japan, median economist estimates in Bloomberg surveys show.

“Everyone is on the short dollar trade,” said Ihab Salib, who oversees more than $3 billion as head of international fixed income at Federated Investments Inc. in Pittsburgh and was betting the dollar would decline from March until it hit $1.4950 per euro in October. “When this happens, a reversal of that trade is likely.”

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