Dollar woes poised to carry over into next year

By Wanfeng Zhou
MarketWatch
Nov. 29, 2006

NEW YORK (MarketWatch) -- After a precipitous slide in the last week that caught many traders off guard, the dollar is vulnerable to further losses and may continue to weaken against major rivals heading into 2007, analysts said Tuesday.

"Sentiment for the dollar has been deteriorating steadily over recent weeks," said Mitul Kotecha, head of global foreign-exchange strategy at French investment bank Calyon. The decline was not prompted by a particular piece of news or data release, "but rather a general worsening in sentiment that saw long held technical levels breached," he said.

"We expect the dollar to weaken further into year end, and retain this tone in the early months of 2007," he said.

The greenback has certainly come under fire in the past week, with the euro pushing through $1.30 on Friday for the first time since April 2005 and the British pound hitting its highest level since Dec. 2004. Traders at first attributed the sharp move to a lack of liquidity with many market players absent for the Thanksgiving holiday.

But the dollar has continued to fall this week and analysts are citing a variety of factors as reasons for the slide, including the U.S. government's reduced expectations for economic growth, worries over the narrowing interest-rate differential between the U.S. and other economies, continued talk of reserve diversification by central banks worldwide, and a warning from China about the risk to Asian currency reserves from further dollar declines.

On Tuesday, the currency touched a fresh 20-month low versus the euro and two-year low versus the British pound after mixed economic reports showed demand for U.S.-made durable goods declined more than forecast last month.

The dollar last traded up 0.1% at 116.14 yen, while the euro was up 0.5% at $1.3197. See currencies column.

"The next major objective you have to look for is the record high in the euro versus the dollar" at above the $1.36 reached at the end of 2004, said David Gilmore, a partner at Foreign Exchange Analytics. "It's reasonable to look for that in the next couple of quarters."

Kathy Lien, chief strategist at FXCM, said there's also seasonal risk for the U.S. dollar in December. Watch videoed interview with Kathy Lien.

She said a historical analysis conducted by her firm showed that over the past 20 years, the euro appreciated against the dollar in December a full 15 out of 20 times. In the last 12 years alone, the euro rose 10 out of 12 times.

"This suggests that even if we have a strong holiday shopping season in the U.S...the effect on the currency may not be seen until January," the study said. "Any optimism about potential sales that is generated in December may not be reflected in the U.S. dollar's price action that month."

Jim Swanson, chief investment strategist at MFS Investment Management, expects the dollar to drop 15% against the euro and 15% against the yen in the next 12 months.

The U.S. currency has lost about 12% against the euro in the past year and almost 50% over the past five years. Against the yen, the greenback has declined about 3% in the past year and 6% in the last five years.

But some analysts cautioned that even as the U.S. dollar will remain under heavy pressure next year, the upside in the euro may be limited.

As the European Central Bank continues to lift interest rates, growth in the euro zone will likely be crimped, holding euro-area policy rates "close to current market expectations," said Steven Saywell, senior currency strategist at Citigroup.

Meanwhile, an economic slowdown in the U.S. will likely have a spill-over effect on Europe and the rest of the world, analysts said. Concerns over a slowing euro zone economy will force the European Central Bank to pause after lifting interest rates to 4% in 2007.

From spring on, the focus of dollar depreciation should "shift in a more visible fashion, from the euro and other G10 major currencies, toward emerging Asian currencies," Saywell said.

As a result, "euro/dollar is likely to decline over the course of 2007," he said. "It's no longer safe to assume that the euro will bear the brunt of any dollar decline."