Dollar shortage fuels US currency’s advance

By Peter Garnham

Published: March 4 2009 11:33 | Last updated: March 4 2009 11:33

The dollar rose to a fresh three-year high against a basket of currencies on Wednesday as concerns over the health of the global economy continued to drive investors towards US assets and the dollar, pressuring supply of the currency.

The dollar also hit a four-month peak against the yen.

Its rise came despite concerns expressed by the Federal Reserve over the rising US government deficit.

Ben Bernanke, Fed chairman, suggested there was a fear in the future that global lenders could “balk”, if the US were not able to control its budget deficit.

“Under normal circumstances, a rising deficit works against the domestic currency,” said Hans Redeker at BNP Paribas.

“However, in this environment, deleveraging by institutions in order to clean up balance sheets will provide the dollar with a natural bid.”

This deleveraging helped create a dollar shortage that drove the US currency sharply higher against the euro after the collapse of Lehman Brothers last September.

Analysts said a similar situation seemed to be developing as equity markets plunged below their lows from last Autumn.

“Although the most intense period of European banks closing funding positions for US subprime and other US structured products seems largely over, deleveraging may not be finished as an FX driver,” said Ray Farris at Credit Suisse.

Derek Halpenny at Bank of Tokyo Mitsubishi UFJ said with carry trade positions now unwound, the dollar shortage problems that had been evident since the collapse of Lehman Brothers were now supporting the dollar against the yen.

The yen found support in the wake of Lehmans demise as asset markets plunged and carry trade investors unwound positions in higher-yielding assets that had been previously funded by selling the low-yielding Japanese currency.

Mr Halpenny said Japan was now trying to alleviate its funding gap, estimated in a report earlier this week to stand at $600bn by the Bank for International Settlements, by utilising is foreign exchange reserves.

Japan announced it would lend Japan Bank of International Co-operation $5bn to alleviate the strains on companies.

“The JBIC announcement in Japan and the BIS report both underline the scale of dollar demand that persists and the process of deleveraging suggests continued dollar support that now also includes the dollar/yen rate with yen carry positions liquidated,” said Mr Halpenny.

The dollar index, which tracks its progress against a basket of currencies, rose to a high of 89.552, its strongest level since April 2006.

The dollar rose 1.2 per cent to Y99.30 against the yen, gained 0.3 per cent to $1.2515 against the euro and climbed 0.5 per cent to SFr1.1810 against the Swiss franc.

The yen also fell 0.9 per cent to Y124.32 against the euro, lost 1.5 per cent to Y139.90 against the pound and dropped 1.5 per cent to Y63.47 against the Australian dollar.

The pound edged higher against the dollar, however, rising 0.3 per cent to $1.4087 after UK economic data came in better than expected .

UK consumer confidence edged higher last month while the service sector purchasing managers’ index also rose unexpectedly.

Howard Archer at IHS Global Insight said news on the UK services sector was particularly welcome given the sector’s dominant role in the UK economy and gave a limited boost to hopes that the rate of decline in activity might be bottoming out, even if recovery still looked a very long way away.

But he said the news was unlikely to stop the Bank of England taking further action to boost the economy after its monetary policy committee meeting Thursday, as the economy was still deep in recession while inflationary pressures were waning markedly.

“We expect the Bank of England to cut interest rates by a further 50 basis points from 1 per cent to 0.5 per cent despite some reservations within the MPC about how much overall good this will do,” said Mr Archer.

“In addition, the Bank of England seems highly likely to announce that it is to commence quantitative easing.”

The pound rose 0.6 per cent to £0.8880 against the euro.