Skip to main content

The U.S. dollar has long had a cachet as a safe haven.


Currency traders are betting on a lower U.S. dollar as interest rates in other leading economies look set to rise while the Federal Reserve stands pat, a glimpse of what could become a more enduring shift as market faith in the greenback slowly ebbs away.

When European Central Bank president Jean-Claude Trichet all but said last Thursday that he plans to raise interest rates in April to keep inflation in the 17-country euro zone from accelerating, a big gap opened up in expectations for monetary policy. Two days earlier, Federal Reserve chairman Ben Bernanke made clear to lawmakers on Capitol Hill that he is still comfortable with extraordinarily low borrowing costs, and that he has no intention of scaling back the central bank's bond-buying program before it runs its course in June.

Policy makers in emerging markets from China to Brazil have already tightened this year, and central bankers from the Bank of Canada's Mark Carney to the Bank of England's Mervyn King are expected to follow suit well before the Fed.

Story continues below advertisement

As the gulf between the U.S. central bank and others widens, and as concerns ease that Europe's debt problems could lead to a breakup of the euro zone, investors are "short selling" the U.S. dollar - betting that it will decline in value - and flocking to the euro to take advantage of the coming difference between European and U.S. interest rates.

Several analysts still see the greenback's recent slide as a temporary swing that could reverse itself once the Fed starts raising rates, perhaps by the end of 2011. Still, alarm bells rung by Mr. Bernanke and the International Monetary Fund hint that the current episode may be a taste of things to come. A weaker currency would help U.S. companies sell their wares abroad, but those benefits could be overwhelmed if a selloff occurs because faith erodes that the U.S. government can make good on its debt obligations and calls increase for a new world reserve currency.

"I'm not certain that people are losing faith as opposed to trying to make a quick buck on a weaker buck," said Michael Gregory, a senior economist with BMO Nesbitt Burns, noting that the share of foreign holdings of U.S.-denominated debt continues to rise, a sign that bond markets haven't yet concluded that Washington is too risky a borrower.

At the same time, Mr. Gregory acknowledged that "over time, as a theme we have been seeing efforts to diversify U.S.-dollar holdings, not only among large institutional investors but particularly central banks, sovereign-wealth funds - those that have always used the U.S. dollar as core holding for liquidity purposes."

Amid concerns about a looming fiscal crisis in the world's biggest and most important economy, and as tensions in the Middle East and North Africa raise the prospect of energy prices rising so high that they slow or even derail the global recovery, the selloff of U.S. dollars that's so far happening "at the margin" could broaden.

David Watt, a senior currency strategist at RBC Dominion Securities, said in an interview that while the amount of time the United States has before investors turn away from the dollar on a larger scale remains "the million-dollar question," it is a matter of when, not if.

``What we're talking about is the speed with which it will continue to lose altitude," Mr. Watt said, pointing to factors like questions around whether fiscal stimulus measures in the United States are achieving their desired effect, and Washington's persistent failure to come up with a long-term plan to attack the country's debt.

Story continues below advertisement

"We're not getting the growth rebound, so we're not getting the rebound in revenues, so you get this idea that, yeah, maybe the U.S. debt situation is going to be a little bit more challenging than we had anticipated.'' Still, until that so-called day of reckoning, a lower greenback has its perks.

President Barack Obama is trying to double U.S. exports over five years, and the weaker dollar helps American companies compete overseas with Asian or Latin American rivals.

Also, as recently as last month, the IMF told Group of 20 policy makers in a report that it views the greenback as overvalued, suggesting that "some further real effective depreciation" of the U.S. dollar would help rebalance the global economy.

And depending on its size, the boost that a weaker dollar could give the American rebound could benefit Canadian exporters too, even as it pushes the loonie higher.

"If we do see the U.S. economy really benefiting from a weaker U.S. dollar and growth is picking up, presumably stronger growth in the U.S. sucks in Canadian exports, regardless of the loonie," Mr. Gregory said.

Meanwhile, recent research suggests that prospects for the U.S. economy have more influence on the Canadian currency in certain situations than energy prices, despite the notion of the loonie as a "commodity currency" because of the country's status as a net oil exporter.

Story continues below advertisement

Marc Chandler, global head of currency strategy at New York-based Brown Brothers Harriman, wrote in a client note on Monday that while the loonie is at its highest level against its U.S. counterpart since 2007, it is actually among the weakest performers among the Group of 10 major currencies since Feb. 15, gaining less than 2 per cent even as oil prices soared 25 per cent.

Mr. Watt noted that in a fragile recovery where oil prices are being driven by concerns about supply, the relationship between oil prices and the loonie breaks down at $100 (U.S.) a barrel. At that point energy costs can become an impediment to growth.

"If oil prices are rising because demand is going up and the global economy is firing on all cylinders, then it's out-and-out positive for the Canadian dollar," he said. "But if oil prices are going up for other reasons ... and not reflecting underlying demand fundamentals, it's much less clear.''

With files from reporter Kevin Carmichael in Washington, and Bloomberg News.

Report an error Licensing Options
About the Author
Economics/business writer

Jeremy has covered Canadian and international economics at The Globe and Mail since late 2009. More

Comments are closed

We have closed comments on this story for legal reasons. For more information on our commenting policies and how our community-based moderation works, please read our Community Guidelines and our Terms and Conditions.