Dollar bulls vanish as holdout UBS predicts drop

Staff Writer
Columbus CEO

September 30, 2013 (c) 2013, Bloomberg News.

NEW YORK - When UBS capitulated on a bet the dollar would gain versus the euro, it was the clearest sign yet of how traders and strategists from Tokyo to London and New York are turning against the U.S. currency.

Until this month, the Swiss lender was more optimistic than the average in a Bloomberg survey of 66 firms, predicting an advance to $1.28 per euro by year-end. Instead, the currency weakened to a seven-month low of $1.3569 on Sept. 19. UBS now sees the greenback depreciating toward $1.3711, before trading at $1.35 on Dec. 31.

UBS joined firms from Goldman Sachs to Royal Bank of Scotland in cutting the outlook for the world's primary reserve currency.

Waning confidence in the dollar couldn't come at a worse time for the U.S. with a budget stalemate in Congress set to shut down the government from Tuesday and foreign central banks reducing Treasury holdings by the most since 2011. The Federal Reserve's surprise Sept. 18 decision to maintain the $85 billion of monthly bond purchases it uses to boost the economy is contributing to calls for dollar weakness.

"If the consensus were to shift toward our new line of thinking, then it could easily develop into a more protracted phase of dollar weakness," Gareth Berry, a Singapore-based currency strategist at UBS, said in a Sept. 26 phone interview. The U.S. central bank's decision "represents a significant shift in the Fed's thinking, and it's not just a temporary delay for a meeting or two. It could be easily the first quarter before tapering begins."

The dollar has slipped 1.1 percent against the euro since Fed Chairman Ben Bernanke said policymakers wanted to see more evidence of the U.S. economic recovery before reducing the pace of stimulus. It has fallen 3.6 percent in the third quarter, the biggest decline since the 5.5 percent drop at the start of 2011.

The central bank may not raise its target interest rate for overnight loans between banks from the zero-to-0.25 percent target range it has maintained since December 2008 until the jobless rate is "considerably below" 6.5 percent, Bernanke said. The rate was 7.3 percent in August.

The Fed's decision not to taper was as surprising as its "much strengthened" interest-rate guidance, according to Thomas Stolper, the chief currency strategist at Goldman Sachs in London.

"The latter may be more important for the dollar," Stolper said in an e-mailed response to questions on Sept. 26. "With stronger forward guidance, tapering has become less relevant for the dollar outlook."

Goldman Sachs cut its outlook on the dollar on Sept. 12, predicting it will weaken to $1.38 per euro in three months, compared with a previous forecast of $1.34. The firm cited the euro region's improving economy. An index of economic confidence in the euro area rose for a fifth month, to 96.9 from 95.3 in August, the European Commission in Brussels said Sept. 27.

The dollar won't gain "substantially" before the Fed raises interest rates in 2016, Stolper said. The median year-end forecast has fallen 1.5 percent this month to $1.30 per euro, data compiled by Bloomberg show.

Hedge funds closed positions due to uncertainty about the Fed, signaling the dollar will be weak for the coming three months, Mansoor Mohi-uddin, the Singapore-based head of currency strategy at UBS, wrote in a Sept. 28 research note after meeting 100 U.S. hedge fund and real money managers.

Futures traders more than doubled net bets on dollar declines versus the euro to 65,844 on Sept. 24, compared with 31,907 a week earlier, data from the Washington-based Commodity Futures Trading Commission show.

Deutsche Bank AG, the world's biggest currency trader, is maintaining its bullish position on the dollar, saying it expects the U.S. recovery to remain on track.

While the greenback may drop toward this year's low of $1.3711, it will rally to end 2013 at $1.20 per euro, according to the biggest German lender.

"The U.S. economic recovery will strengthen in the months ahead and the Fed will commence a taper of its bond purchases in December," John Horner, a Sydney-based strategist at Deutsche Bank, said by phone on Sept. 27.

Potential stimulus measures by the European Central Bank will weaken the euro to the benefit of the dollar, said Sara Yates, a currency strategist at JPMorgan Chase & Co. in London. ECB President Mario Draghi said Sept. 23 he's ready to deploy another round of loans to keep Europe's banks properly funded.

"We do expect Draghi to be dovish in his communications and keep euro-dollar contained," said Yates, who predicts the U.S. currency will trade from $1.28 to $1.36 per euro.

While New York-based Morgan Stanley cut its year-end dollar forecast, it maintained a longer-term bullish view, estimating an advance to $1.23 per euro by the end of 2014. The firm sees the U.S. currency at $1.30 at the end of this year, compared with a previous forecast of $1.28.

UBS expects the greenback to strengthen toward $1.20 by the end of next year.

"The more supportive policy stance in the near term has the potential to cultivate an attractive investment environment in the U.S., encouraging domestic investment, as well as drawing in longer-term foreign direct-investment flows, allowing the dollar to resume the uptrend over the coming year," Ian Stannard, the head of European foreign-exchange strategy at Morgan Stanley in London, wrote in a Sept. 26 report.

The Bloomberg Dollar Index was little changed Monday, poised for its biggest monthly decline since October 2011, as the U.S. government faces the chance of its first partial shutdown in 17 years with Congress deadlocked over Republicans' insistence on delaying the 2010 health-care law.

Congress is leaving itself just one day to end the budget stalemate before the government's spending authority expires Tuesday. Neither chamber was in session Sunday and no negotiations were evident as lawmakers went on the talk shows to blame the other party for the stalemate.

A brief government shutdown won't lead to any significant change of the Treasury Department's forecast for when the U.S. will breach the debt limit, a Treasury spokeswoman said Sunday in an e-mail. The Treasury has said measures to avoid breaching the debt ceiling will be exhausted on Oct. 17.

The political wrangling comes as international investors and central banks cut their holdings of U.S. government debt. The amount of Treasuries held by the Fed on behalf of its foreign counterparts fell $17.5 billion this quarter to $2.9 trillion, the biggest decline since the final three months of 2011, according to data compiled by Bloomberg.

Confusion about when the Fed will start to reduce its bond purchases deters investors from buying the dollar, according to Adnan Akant, the New York-based chief investment officer for currencies at Fischer Francis Trees & Watts Inc., which oversees $64 billion.

"I'm moving away from the dollar," Akant said in a Sept. 18 phone interview. "What's going on isn't particularly positive for the dollar, especially as global growth is picking up generally, not just in the U.S."

Other banks have downgraded their views of the dollar since the Fed's decision on stimulus this month. Bank of America Corp. lowered its year-end prediction to $1.30 per euro from $1.25, while Royal Bank of Scotland said it cut its call to $1.32.

"The environment is one of a more accommodative Fed and headwinds for the U.S. dollar, and that continues for a little while," Paul Robson, senior currency strategist at RBS in London, said in a Sept. 26 phone interview. "Even if we get some stronger data, the markets will wait until the Fed signals that tapering is back on, and that's not something that's likely to happen till early next year."