Friday, December 30, 2005


US Dollar's Fate In 2006 Rides With Rate 'Story'

Reuters takes a look at prospects for the US dollar in 2006. "After a surprise 2005 in which the dollar rose, against the predictions of many analysts, the U.S. currency is likely to fall in 2006. But exactly when and how hard, they say, will depend largely on how the U.S. interest rate story plays out."

"But while the focus on interest rates isn't expected to change, the story itself is. In 2005, the dollar lifted steadily as the Federal Reserve continued raising short term interest rates in the United States, bringing them to 4.25 percent by the end of the year. Rates in the euro zone and Japan, meanwhile, remained largely stagnant. But in 2006, the key for major currency markets will be the end of the Fed's rate raising cycle, and the degree to which the euro zone and Japan will be raising rates."

"Of course, the consensus could be wrong, just as it was a year ago. At the end of 2004, a vast majority of analysts failed to foresee the dollar rising from its multiyear lows hit in December of that year. Indeed, many had expected the dollar to continue plunging in 2005 due to concerns about funding the U.S. current account deficit."

"Of course, it's a different situation now, particularly because the Fed is broadly expected to stop hiking rates in 2006. In addition, the Bank of Japan is expected to finally start tightening its own policy while the European Central Bank, which raised rates by a quarter-point in 2005 to 2.25 percent, is seen increasing its short-term rates at least two more times, although action beyond that remains a question mark."

"Several banks see the dollar appreciating substantially in the months ahead before retreating sharply in the second half. For example, JP Morgan sees the euro falling to $1.16 by the end of March and $1.15 by midyear, before lifting to $1.25 at year end. A few see a bullish 2006 for the U.S. currency. Credit Suisse First Boston and Bank of Tokyo Mitsubishi are some of the banks forecasting a substantially stronger dollar next year."

"Largely absent from analysts' outlook for 2006, meanwhile are predictions of any extraordinary performance for Asian currencies, particularly the yen. A year ago, expectations were that the yen and other Asian currencies would be the star performers in 2005, based on a belief that a revaluation of the Chinese yuan would take some competitive pressure off Japan and other Asian nations and make them more comfortable with stronger domestic currencies."

"That prediction turned out to be a bust. Indeed, China revalued modestly, but it barely made a dent in yen's sell-off versus the dollar. For 2006, analysts expect China will allow the yuan to continue edging higher under the country's more flexible currency policy. But they are clearly now more cautious about whether that will necessarily translate into a stronger yen."

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