7 reasons why the dollar is the best of a very bad bunch

September 19th 2011: 7 reasons why the dollar is the best of a very bad bunch

Looking at the dollar fundamentals in isolation, investors would be right to conclude that the currency has a horrendous future. Currency markets, however, have to look at the complete picture and this is where the dollar is still the least bad option in the short term. Caution is required given Fed Chairman Bernanke’s habit of being even more dovish than expected, but there should be solid dollar buying support on dips.

1. The US Treasury market is still the most liquid global asset class and, despite the Standard & Poor’s US credit-rating downgrade, it remains the ultimate safe-haven for funds, especially when international equity markets are on the defensive.

2. With confidence in the global economy also deteriorating, there is likely to be an important flow of funds out of risk-based assets and emerging markets. This will ease selling pressure on the dollar and there will also be an substantial impact from a reduction in Asian central bank Euro buying. Indeed, there is the possibility of Euro selling by Asian banks if stresses intensify and they intervene to sell the US dollar against their own currencies.

3. The Euro area has shown increasing political discord over the past week as it seeks to deal with the sovereign-debt crisis and the net risks have continued to increase as the Greek crisis reaches a climax. Liquidity issues have been addressed, but solvency fears in the banking sector will continue and the economy is set for a sharp slowdown which will further exacerbate political tensions. There is the possibility of a hard Euro being created out of the wreckage, but this is a long-term play and the near-term risk is of capital flight from the Euro area.

4. Sterling has no risk of a debt default and will gain some support from its position outside the Euro-zone. Nevertheless, the economic fundamentals remain bleak and the UK will not be able to escape from severe damage if the Euro-zone implodes. Given the private and public-sector debt profiles, there is a high risk of credit-rating downgrades.

5. The Swiss National Bank has laid its credibility on the line with a minimum level against the Euro. The franc could be back in the game in the medium term as the minimum level can only be a short-term fix and there will be private funds moving into Swiss assets.

6. The Australian dollar is at risk of being exposed to a ‘perfect storm’ and being exposed to heavy selling. There will be an important negative impact on the economy from the global slowdown in growth. Australia will also be very exposed to selling pressure if there is a severe downturn in China. The domestic economy is also highly vulnerable to an unwinding of excessive credit growth.

7. The short-term Chinese economic outlook is looking extremely vulnerable as the country will have to face the implications of a severe credit hangover following the monetary binge. There is a growing threat of a sharp deterioration as the full scale of debt problems become clear with bailouts required for a high number of lenders.

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