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The US Dollar and US Equities

International Monetary Fund's latest figures show that dollar's share of global foreign exchange reserves is high - 63%, down only 2% points from 1997. In other words, there has not yet been a seismic shift in allocation away from the dollar. Foreign buying of US treasuries remains strong.

As of 15 August 2008, dollar has reached a six-month high against the euro, rising to $1.471 per euro. But fund managers and financial advisers remain sceptical about the strength of US equities, despite the growing consensus that the American economy is not deteriorating as quickly as others across the global.

Indeed, US equities are not performing poorly when compared with emerging markets and Europe. Since the start of the year, the S&P 500 has fallen 12.43%, while the FTSE 250 is -19.5%, the Nikkei 225 is -13.8% and the FTSE Euro 300 is -20.1%.

Mick Gilliagan, head of research at the broker Killick & Co, put it "The US economy is just the best of a bad lot."

English: The International Monetary Fund (Head...

English: The International Monetary Fund (Headquarters 2) located at 1900 Pennsylvania Avenue, N.W., in the Foggy Bottom neighborhood of Washington, D.C. The 12-story, postmodern high-rise was built in 2005 to the designs of Pei Cobb Freed & Partners. (Photo credit: Wikipedia)

Apparently, some private and institutional investors have begun to move money into the US from riskier markets, on the view that the country will likely be the first to rebound from recession. But mixed earnings figures and pessimistic reports on unemployment and the US housing market are prompting most fund managers to remain cautious.

But global imbalances between the US and currencies pegged to the dollar are not yet fully resolved. A faster appreciation of Asian currencies still makes a lot of sense, as does a re-peg of oil exporters' exchange rates to a basket of currencies. Until there is some progress, the greenback can only make limited gains against free-floating currencies such as the euro and yen.

Any supply disruption halting the oil price decline would also bring both inflation and growth concerns back - especially for the oil-hungry US. If the Fed keeps rates too low for too long, fears of the value of dollar assets being eroded by inflation may yet lead investors to walk away from the dollar.

Currencies tend to overshoot and bounce back like a yo-yo. The recent appreciation of the dollar is a correction from its deep fall. But it is unlikely to be the start of a prolonged recovery and may be over after the first hooray.

Reference:

  1. Financial Times, Lex Macroeconomics & markets, 2008-08-01, "The US dollar"

  2. Financial Times, Ellen Kelleher, 2008-08-15, "US equities not yet rosy, despite greenback bounce"

  3. Financial Times, Editorial Comment, 2008-08-19, "Dollar on the rise, at least for now"