Thursday, August 17, 2006

Dollar declines. Forecast: end to rate raising cycle

From Bloomberg's report, "Dollar Declines as Expectations of Fed Rate Increases Recede":

The dollar dropped to the lowest in a week against the euro and the yen as reports this week showing slowing inflation eased expectations for further interest-rate increases this year by the Federal Reserve.

The South Korean won, Brazilian real, Swiss franc and South African rand also strengthened versus the U.S. currency. The yield advantage of dollar-denominated assets over those in 12- nation euro region has narrowed to the smallest in a year as speculation increases the Fed is done boosting borrowing costs.

``The dollar is losing interest-rate support,'' said Christian Dupont, a senior currency trader at Societe Generale SA in Montreal. ``There is a bigger sense that the Fed is coming to the end of its rate hike cycle. I think they are done. This weighs on the dollar.''

The dollar declined for a third day to 115.50 yen at 10:26 a.m. in New York from 115.86 late yesterday. It also weakened to $1.2865 per euro from $1.2839. Euro fell to 148.58 yen today after hitting 148.90 yen yesterday, the strongest since the currency shared by 12 European nations debuted in Jan. 1999 at about 133.49 yen.

The U.S. currency will slide to $1.30 per euro and 113 yen in a month, said Dupont.

The key concept in this article is the comment about the dollar losing interest-rate support. This suggests people are not willing to hold dollars or dollar denominated debt without the incentive of a significant interest rate.

Investors and central banks might be thinking, "why should we hold so many dollar denominated assets when we can diversify into stronger currencies or higher-yielding currencies".

Here's how Reuters summed it up in their report on the dollar: "With signs that the Fed may keep rates steady amid indications that other central banks such as the European Central Bank may continue raising rates, the dollar has lost some of its luster."