Dollar gains as risks spike; upside seen limited

LONDON - Global inflation fright and a spike in risk aversion have come to the aid of the ailing dollar in recent weeks, but the ranks of dollar bulls are not swelling.

By (Reuters)

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Published: Sun 11 Jun 2006, 10:57 PM

Last updated: Sat 4 Apr 2015, 3:24 PM

Central banks from Seoul to Johannesburg have raised interest rates to douse inflationary expectations, and with markets increasingly worried about a slowdown in global growth, the dollar has been a beneficiary of investors’ flight to safety and capital protection strategy.

A jump in risk premium has led to a steep sell-off in high-yielding emerging market assets and commodity markets and has wiped off billions of dollars in value from global equity markets.

But gyrations in financial markets do not seem to have rattled finance ministers from the world’s major economic powers, who met this weekend in St Petersburg.

The Group of Seven industrialised nations said growth remained strong, reiterated that global economic adjustment was a shared responsibility and reaffirmed their commitment to address global imbalances.

“Rather than suggesting the G7/G8 has changed its mind on the degree of emphasis they place on correcting global imbalances, the reduced emphasis on this particular issue reflects the different purpose of this latest meeting,” said Singapore-based Adrian Foster, a forex strategist at Dresdner Kleinwort Wasserstein.

With top central bankers staying away, this weekend’s meeting was best seen as a preparatory forum for the leaders’ summit in July, Foster added.

While the G7 gave no official guidance to the foreign exchange markets, comments from top policymakers showed they were not worried about recent market movements.

International Monetary Fund chief Rodrigo Rato said the dollar’s current value reflected economic fundamentals, and French Finance Minister Thierry Breton signalled the euro was ”fully valued” at levels of around $1.30.

The dollar has lost nearly 7 percent against the euro so far this year and was quoted at $1.264 in New York on Friday.

But last week the greenback posted its best weekly gain against a basket of currencies in more than a year after reports showed the US trade deficit had widened less than expected in April, and a rise in import prices boosted hopes of a Fed rate hike later this month.

“We rate the dollar’s recent rally versus the euro as unsustainable. Note that speculative euro-longs on the IMM (International Monetary Market) had increased 11 percent to a new record high over the week ended June 6, showing how vulnerable the market was to a technical correction,” Foster said.

Orderly adjustments?

Global central banks face a tightrope walk of balancing between monetary tightening to keep a lid on inflation and ensuring that rate hikes do not choke growth.

While most analysts view the recent stock and emerging market sell-off as a correction, the question now facing global policymakers is whether markets can digest volatility along with tightening liquidity conditions.

“The likely results are higher long-term yields and greater volatility across asset markets near term,” said BNP Paribas in a research note.

“Ongoing near-term swings should ultimately translate into higher volatilities further down the FX term structures as markets realise that higher volatility is here to stay,” it added.

Investors will comb a speech from Federal Reserve Chairman Ben Bernanke and US consumer inflation data this week for clues on future trajectory of US monetary policy.

Economists polled by Reuters forecast core prices, excluding volatile food and energy, to have risen 0.2 percent on the month and 2.1 percent on the year. Headline inflation is forecast to stand at 0.3 percent in May and 3.9 percent year on year.

But the key challenge confronting the Fed is that if growth expectations remain subdued, higher inflation numbers might not be enough to justify any aggressive monetary tightening.

Niels Christensen of Societe Generale warned that fears of slower growth, as reflected in weak May US payrolls data, and higher inflation is a dangerous cocktail for stock markets.

SG says the dollar is unlikely to build on its recent gains.

“We still expect to see the euro/dollar move back to $1.30 in the months ahead and reach a level of $1.32 by the end of Q3 (third quarter), when we are convinced that the peak of the rate-hiking cycle in the US will be behind us,” it said in a note.

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