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Dollar Bears Pare Bets as QE2 Attacks Prove Unfounded (Update2)
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By Catarina Saraiva


Nov. 22 (Bloomberg) -- At a time when foreign officials and U.S.
lawmakers are criticizing the Federal Reserve’s plan to buy Treasury
bonds, the currency market is voting in favor of Ben S. Bernanke’s
quantitative easing.

The Dollar Index measuring the currency’s performance against those of
six major trading partners has climbed as much as 5.1 percent from its
low this year on Nov. 4. Futures traders have slashed bets for a
decline in the dollar against the euro, yen, Australian dollar and
Swiss franc, data from the Commodities Futures Trading Association in
Washington show.

Leaders from Chinese Premier Wen Jiabao to John Boehner, the nominee
to be the next speaker of the House of Representatives, have said Fed
Chairman Bernanke’s plan to print money and buy $600 billion of U.S.
government debt will cause instability and faster inflation. The $4
trillion-a-day currency market is signaling the Fed’s strategy is
unlikely to debase the dollar as long as the economy continues to
strengthen.

“The dollar has found a bottom,” said Lane Newman, director of foreign
exchange in New York at ING Groep NV, the largest Dutch financial-
services company.

Strategist forecasts for the dollar to weaken have all but ceased.
Since mid-October, the average of 38 estimates in a Bloomberg survey
has been for the currency to trade at about $1.36 to the euro by
mid-2011. It ended last week at $1.3673.

‘Clueless’ Policy

German Finance Minister Wolfgang Schaeuble said Nov. 5 the Fed’s
policy was “clueless” and unlikely to revive growth. Brazilian Finance
Minister Guido Mantega, who used the phrase “currency war” six days
after the Fed suggested at its Sept. 21 meeting it was willing to ease
monetary policy, said Nov. 4 the U.S. is throwing “money from a
helicopter” and may cause asset bubbles to form.

Bernanke defended the decision in a speech last week in Frankfurt,
saying it’s the best way to underpin the dollar and support the global
recovery. Economists at London-based Barclays Capital said in a Nov.
19 report that U.S. growth will accelerate this quarter from 2.4
percent in the three months ended Sept. 30, while the 16-nation euro
zone goes through “turmoil” amid talks to bail out Ireland.

Ireland applied for a bailout to help fund itself and save its banks,
becoming the second euro member to seek a rescue from the European
Union and the International Monetary Fund. Irish Finance Minister
Brian Lenihan said the loan will be less than 100 billion euros ($138
billion), refusing to give any further details at a press conference
in Dublin yesterday.

Investor concern that Ireland may default drove up yields on its 10-
year bonds last week to 6.46 percentage points more than those on
German bunds of similar maturity, a record.

Turning Bullish

“It’s become almost fashionable to criticize the Fed,” though Europe’s
fiscal crisis has “changed the picture quite a bit,” said Vassili
Serebriakov, a currency strategist at Wells Fargo & Co. in New York.

Wells Fargo, the third-most accurate currency forecaster of 44 firms
tracked by Bloomberg for the six quarters ending Sept. 30, estimates
the dollar will end the year at $1.38 to Europe’s common currency, and
gain to $1.34 in 2011. Last month, the firm was calling for an
exchange rate of $1.43.

IntercontinentalExchange Inc.’s Dollar Index fell 0.5 percent to
78.134 as of 9:45 a.m. in London today, dropping for a fourth day.
That’s still below 82.918 level on Aug. 27, when Bernanke said the
central bank “will do all that it can” to keep the recovery on track.
That sparked speculation that the Fed would conduct a second round of
so-called quantitative easing and keep interest rates at record lows
through 2011.

Open Letter

“The dollar cannot mount a sustainable rally in the face of
quantitative easing,” said Richard Franulovich, a senior currency
strategist at Westpac Banking Corp. in New York. “The Fed is capping
U.S. interest rates and by doing that, it’s making the dollar an
unattractive currency compared to other countries with higher interest
rates.”

A group including former Republican government officials and
economists wrote an open letter to Bernanke, published Nov. 15, saying
the asset purchases “risk currency debasement and inflation” and won’t
curb a U.S. jobless rate that has held above 9 percent since May 2009.

The best way to underpin the dollar and the global recovery “is
through policies that lead to a resumption of robust growth in a
context of price stability in the United States,” Bernanke said in a
speech in Frankfurt on Nov. 19. Countries that undervalue currencies
may inhibit growth around the world and risk financial instability at
home, he said.

Foreign Demand

Treasury Department data last week showed global investors bought a
net $81 billion of U.S. stocks, bonds and other financial assets in
September, above this year’s average of $71 billion, after Bernanke
laid out the bond purchase plan the previous month to central bankers
in Jackson Hole, Wyoming.

During the first round of quantitative easing, the Fed bought $1.725
trillion of government and mortgage bonds between November 2008 and
March 2010. In the past three years the Dollar Index has ranged from a
low of 70.698 in March 2008 to as much as 89.624 in March 2009. This
year’s high was 88.708 in June.

Investors may prefer the dollar as the Fed’s effort to avoid deflation
by injecting more cash into the financial system shows signs of
succeeding. A general decline in consumer prices tends to hurt a
currency because international investors have less incentive to buy
assets in that nation.

Yields on 30-year Treasury bonds, which are most sensitive to changing
expectations for faster inflation, rose last week to 4.42 percent, the
highest since May.

Pimco’s Take

“The long end of the market is telling you to give Mr. Bernanke and
his colleagues the benefit of the doubt that this thing can be
successful,” said Paul McCulley, a managing director at Newport Beach,
California-based Pacific Investment Management Co., which runs the
world’s biggest bond fund. McCulley made the comments last week in an
interview on Bloomberg Radio’s “The Hays Advantage” with Kathleen Hays.

Futures traders have slashed bets the dollar will weaken against the
euro. The number of contracts hedge funds and other large speculators
hold at the Chicago Mercantile Exchange betting on a gain in Europe’s
currency tumbled to 8,606 as of Nov. 16 from the high this year of
48,243 on Oct. 8, according to Commodity Futures Trading Commission
data.

Traders “overshot” on the dollar’s weakness and “we’re now seeing a
reversal of that,” said Jeffrey Young, head of North America foreign
exchange research at Barclays in New York. “It makes sense that the
dollar is going to have to rise” as bond yields in the U.S. increase,
he said.

Broad Rally

Since the Dollar Index’s low this year on Nov. 4, America’s legal
tender has risen against 15 of its 16 most-widely traded counterparts
tracked by Bloomberg. It gained the most against Sweden’s krona,
rising 4.2 percent, followed by 3.6 percent versus Norway’s krone and
3.1 percent compared with the franc.

UBS AG, the second-largest currency trader behind Deutsche Bank AG,
raised its one-month forecast last week for the dollar on signs of
recovery in the U.S. economy and Europe’s lingering fiscal crisis.

The Zurich-based firm sees the greenback strengthening to $1.30 per
euro in a month, compared with its previous estimate of $1.40,
according to a research note dated Nov. 15. The U.S. currency may
climb to 85 yen in one month, from a previous target of 80 yen, it
said. The dollar traded at 83.44 yen today in London from 83.55 yen in
New York on Nov. 19.

“Europe’s fiscal troubles are set to continue and the U.S. economy is
starting to revive after summer weakness,” analysts led by Mansoor
Mohi-uddin, the Singapore-based chief currency strategist at UBS,
wrote in the note. “We expect investors to look more favorably on the
dollar now.”

To contact the reporter on this story: Catarina Saraiva in New York atasaraiva5@bloomberg.net

To contact the editor responsible for this story: David Liedtka atdliedtka@bloomberg.net

Last Updated: November 22, 2010 05:13 EST