Mark O' Sullivan examines the continuing downward spiral of the US dollar and its ramifications for global currencies
The dollar has continued on its downward spiral, as the ongoing credit crisis, the collapse of Bear Stearns and the continued injecting of liquidity by the Federal Reserve has left all asset classes in turmoil, with commodities soaring to all-time highs and equity markets seeing daily price swings in excess of 3%.
This crisis remains unique as the rest of the world is feeling the effect of the weak dollar, seeing their own domestic currencies reaching all-time highs.
The euro now trades at $1.58, and despite the fact that European exporters are looking on with heightened nervousness as the euro appreciates even further, the European Central Bank still remains on inflation watch.
A strong currency will help this cause, but it is a fine balancing act to ensure that the strength of the currency does not hurt exporters.
Sterling is performing well against the dollar, trading around $2, but looking across the rest of the globe, it is trading at multi-year lows against the Australian, Canadian and New Zealand dollar, and at an all-time low against the euro at EUR1.27.
The reason for this is the UK, like its US cousin, runs a large budget deficit, and needs a weak currency to shrink this exposure.
That, coupled with the belief the Bank of England will cut interest rates as global growth slows, will ensure sterling remains under pressure throughout the rest of 2008.
There is a school of thought that feels the dollar sell-off could be coming to an end as commodities that look extremely overbought correct themselves, and the slowdown in the US starts to affect global growth overall, leading to central banks around the world embarking on a series of rate cuts to stimulate growth.
One area to keep an eye on is the Middle East and regions that have pegged their currencies against the dollar. The dollar's recent decline has seen these regions' economies suffer as inflation soars.
In 2007, Kuwait moved away from a peg against the dollar to a floating basket of currencies, and rumours continue to surface that the UAE and other Gulf states may follow suit. This will certainly be a story to watch going forward.
To sum up the past 18 months, it has been one of a dollar decline rather than the strength of domestic currencies, and as these economies look like they may overheat or start to slow down, now could be a time to buy dollars looking at an end-of-year rally.
- Mark O'Sullivan is director, dealing, at Currencies Direct.
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