Dow Jones Newswire: Dollar's Decline Starting To Accelerate, Rattling Nerves, 1/25/03

Dow Jones Newswire:
Dollar's Decline Starting To Accelerate, Rattling Nerves

NEW YORK (Dow Jones) -- All of a sudden, the dollar's supposedly slow and gradual decline isn't looking so slow, or gradual.

In fact the speed of the dollar's slide, against the euro in particular, has taken even the most seasoned analysts by surprise: a Dow Jones Newswires foreign exchange survey just ten days ago showed the major currency trading banks forecasting the euro climbing to $1.06 by the middle of February and not coming near $1.10 until the end of the year.

Instead, the euro has leaped to highs of around $1.0850 on Friday and has already gained 4% on the dollar this year, leaving strategists increasingly scrambling to update their forecasts. The Swiss franc keeps reaching fresh four-year highs, and the dollar is on the ropes against sterling and a host of other key rivals.

"When you look back, all of these small steps are making up for a giant leap, particularly for the euro," said Alan Ruskin, research director at 4Cast financial consultancy, in New York.

To be sure, the fact that the dollar is in a bear market is no surprise. The currency lost 15% against the euro last year and 10% against the yen, marking the dollar's steepest fall since after the stock market crash of 1987. But many economists have routinely argued that the greenback's decline was mostly a good thing for the U.S. economy, because it was taking place slowly and in an orderly manner at a time when U.S. manufacturers could badly do with some sort of competitive edge.

At the same time, a gradual decline in the currency -- as against an outright freefall along the lines of the dollar's 13% slide against the yen during two hectic days of Oct. 1998 -- helps to limit the fallout on other U.S. asset markets. But with the dollar continuing to slip this month below apparent lines of technical support, mostly on the resounding drum of war emanating from the Bush Administration, market participants are beginning to ask whether the currency's fortunes will spark broader questions about confidence in U.S. assets.

"Right now we're not there but we could get there," said Ruskin. "We could be in a situation where we're putting two and two together and getting 22."

He said that if the U.S. declares war on Iraq, the stock market could start to slide, which would feed further dollar weakness, creating a vicious circle where foreign investors liquidate U.S. assets and thus put pressure on the dollar, which further inspires more liquidation.

For now, implied foreign exchange volatilities are holding fairly steady and the major currencies are able to absorb greater volume fairly seamlessly.

Perhaps a more important barometer of broader confidence in U.S. markets is the Treasurys market. With the dollar falling, gold spiking and stocks under pressure, Treasurys continue to retain their safe haven appeal.

But there are warning signals here, too, that are beginning to get more attention. This week, the Russian central bank said it was lowering the U.S. asset portion of its foreign exchange reserves -- in other words selling Treasurys -- calling the dollar a low-yielding currency.

Analysts believe some of the large Asian central banks -- that between them hold the lion's share of the world's dollar reserves -- are also considering rejigging their Treasury holdings. A U.S.-led war in Iraq could further accelerate that trend.

Indeed, some political analysts believe that U.S. policy over Iraq may already be having a direct impact on holdings of U.S. assets, particularly with much of the rest of the world so opposed to war. "It's hard for me to believe that the flow of capital cannot help but be affected by how the U.S. is perceived around the world," said Larry Greenberg, an international economist at Ried Thunberg & Co. in Westport, Conn.

This renders next week particularly important for the dollar, with a slew of potentially significant trendsetting events, including Chief U.N. weapons inspector Hans Blix's report to the U.N. Security Council Monday, President George W. Bush's State of The Union address on Tuesday and the confirmation hearings for Treasury Secretary nominee John Snow. For the pace of the dollar's fall, developments concerning the prospect for war will likely rein paramount.

"Today if you have the U.S. acting (in Iraq) against world opinion, there could be an even faster pullback out of dollar-denominated assets," said Joseph Quinlan, global economist with Johns Hopkins University, in Washington. "How we go to war influences the rate of decline of the dollar," he said.