Thursday, October 26, 2006

UBS, Merrill Confounded by Dollar's Strength Against Euro, Yen

Oct. 23 (Bloomberg) -- ``The dollar is not yet out of the woods,'' UBS AG strategists told clients in an Oct. 2 report, as the currency traded higher against the euro and yen than the firm had predicted. The dollar would weaken ``sooner rather than later,'' they wrote.
Within days, they were eating crow. By Oct. 16, UBS had twice raised its one-month dollar forecasts to 119 yen and $1.24 to the euro, up from 114 yen and $1.30. It also raised its three- month dollar estimates. ``Dollar to stay stronger for longer,'' the bank was telling clients.
UBS and Merrill Lynch & Co. have been surprised by the U.S. currency's strength this year. They're betting that traders in the more than $2 trillion-a-day global foreign-exchange market will come around to their view on the dollar as the world's economy cools off.
``As investors have become more positive on global growth, the dollar has managed to confound the long-term bears,'' said Mansoor Mohi-uddin, global head of foreign-exchange strategy at UBS in London. ``The dollar will do well while such sentiment lasts; but once financial markets shift towards pricing in slower global growth, the dollar will start to weaken again.''
A slowdown in the U.S. housing market will weigh on the economy, prompting the Federal Reserve to cut its benchmark interest rate to 4.25 percent from 5.25 percent now, the firm says. The Fed raised borrowing costs 17 consecutive times between June 2004 and June of this year.
Lower interest rates would make the U.S. currency relatively less attractive. In a year, Mohi-uddin predicts the dollar will be changing hands at $1.40 per euro -- or 9.9 percent weaker than its current $1.2608 -- and at 100 yen, 16 percent weaker than last week's close of 118.75 yen.
He's got plenty of company. In foreign-exchange forecasts compiled by Bloomberg News, 32 of the 42 projections have the euro at $1.28 or above by year end, and 22 of the 42 see it at $1.30 or higher. By contrast, only six have the euro trading at $1.25 or lower by Dec. 31.
Meanwhile, 26 of 42 forecasts see the dollar at 115 yen or weaker by year end, while only four of 42 predict it will be at 120 yen or higher.
``A large part of the foreign-exchange market, including ourselves, is bearish on the dollar,'' said Steven Englander, head G-10 currency strategist at Merrill Lynch in New York.
Growing Economies
``The European and Japanese economies are in the upswing; the market is underestimating how high and how fast their central banks will raise interest rates,'' he said. ``Right now, investors are pretty much ignoring the good economic stories in Europe and Japan.''
The European Central Bank's benchmark rate stands at 3.25 percent, having been increased by 1.25 percentage points since December. The Bank of Japan raised its key overnight rate to 0.25 percent from almost zero in July, its first increase since August 2000.