Dollar Set to Undergo Further Decline This Year

Markets are set to be doubly surprised by a fall in the dollar, especially in the second half of 2011, according to Oxford Analytica.

The decline will contrast with safe-haven gains in recent days. Realisation of greater potential for renewal of the Federal Reserve’s quantitative easing programme will also propel the drop. A falling dollar will flatter the returns of foreign investors in domestically denominated emerging-market assets. Yet developing-country governments will probably adopt less assertive currency-management policy.

Worries over commodities and euro-area integrity have driven risk-averse capital into dollar-denominated securities, pushing up the US currency in recent days. Yet, for most of the year, the dollar has been on a downward trajectory.

• Multinationals interested in hedging their exposure to the dollar will continue to do so.
• Emerging-market assets will continue to produce extra returns for foreign investors based on currency appreciation against the dollar.

Particularly in the second half of 2011, the dollar will undergo a pronounced decline.

The dollar regularly comes under pressure when attention turns to the international balance of payments. The US economy has run a deficit with the rest of the world since 1982, with the exception of 1991. In general, international deficits are merely a reflection of deepening integration of global trade and capital markets. Nevertheless, while external accounts need not balance within a given year, they should balance inter-temporally. A series of unending deficits would imply an infinite accumulation of liabilities to the rest of the world, and the world’s willingness to bestow unending credit.

Hence the 30 years of US current account deficits weigh on the dollar; the expectation is that the US current account will eventually shift into surplus (see INTERNATIONAL: US shift to surplus slow, inevitable). This is normally accomplished with a sizeable weakening of the currency.