Brave New World

The end of the USD reserve status? 22/05/2009

The US Dollar is under relentless pressure in the morning of European trading. EURUSD was trading up to 1.3975 level just before 8am, GBPUSD touched just below the 1.5900 level- a level last seen in November 2008, and AUDUSD earlier touched 0.78240 a level last seen in October 2008. The JPY also benefitted from USD weakness, trading down to 93.86 following comments from the Japanese Finance Minister, who said that he was not considering FX intervention. With little in the way of data later today and a long weekend ahead for the UK and US, position squaring and poor liquidity should bring heightened volatility, with a chance of a USD bounce. However, longer term the run on the USD may have started.

The market rally is in its eleventh week and in many respects the last week has seen the greatest level of confidence that conditions are returning to normal. This is witnessed in the steady rise in commodities, an improvement in funding conditions- with TED spreads back to pre-August 2007 levels- and the return to beta currencies in the FX market. Equity markets have had a rocky week but the growing conviction that, given the 35% rise in the S&P since March, we have passed the bottom has led real money investors out of the safety of the US dollar. Other, emerging market, regions around the world appear to be bouncing back quicker than the US, increasing demand for their assets. There has also been much chatter from the Chinese about the future of the US Dollar and its reserve currency status. Earlier this week the FT reported that Brazil and China are working to use their own currencies in trade transactions rather than the USD. The icing on the cake came yesterday when S&P downgrading its view of the UK from Stable to Negative, warning that there was a 1 in 3 chance of having its AAA status downgraded. The UK and US are entering into the same level of fiscal deficit, both are undertaking a massive expansion in debt as a percentage of GDP and both have similar overreliance on the consumer and housing, supports to the economy that are no longer there. Although the UK is a much smaller country and has none of the reserve currency status privileges the US currently enjoys there are serious long term concerns about the level of US debt. This combined with the geopolitical move among emerging market economies to move away from the dollar, and the benign climate, encouraging central banks and investors to move out of dollars, could trigger a run on the dollar. Treasury Secretary Geithner has restated the commitment to a ‘strong dollar’. It is difficult to see what measures he can take to demonstrate this at the moment.