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Currencies: Where to hide?
New York: November 12, 2003
By John R. Stephenson
The data out of the U.S. has been encouraging lately with strong
economic growth recorded for the third quarter of this year
(7.2% GDP growth) and with U.S. production data, purchasing
manager data and consumer confidence data improving in recent
weeks. In fact, economic data for the G-7 (seven largest economies
in the world) has also seemed to be trending upwards (see figure
1). Yet the mood on the street is decidedly somber with the
broad indices trading down for the past three sessions and with
CNN’s Lou Dobbs talking about the “exporting of
America”. Last week Alan Greenspan (chairman of the Fed)
mentioned that the Fed was in no hurry to raise interest rates
because “the probability, though minor, of an unwelcome
fall in inflation exceeds that of a rise in inflation”
- a sign that the Fed is concerned that the U.S. economy may
not yet have turned the corner.
Figure 1: G-7 Indicators
The Fed has some good reasons to be concerned about the state
of the U.S. economy. Last month, we saw a rise in consumer
credit (household debt) and the national savings rate for
October dipped below 3% of disposable income. As well, capacity
utilization for industry is running below 75%, which negates
the possibility of increased investment in domestic capacity
anytime soon. Certainly one consequence of an increasingly
global world is that a greater percentage of the manufacturing
is, in fact, being exported abroad.
In order to fund domestic growth over the last few quarters,
the U.S. has continued to borrow money. How much money? So
far, the total tab of all U.S. government borrowing stands
at $3.8 trillion (total U.S. debt outstanding including corporate
bonds is $21 trillion - about twice the GDP). Of that amount,
foreigners hold about 26% of the total including 36% of the
total in U.S. treasuries and 13% of the U.S. agency debt.
This, of course, makes the U.S. vulnerable to economic conditions
and sentiments abroad. How long can the borrowing continue?
It depends, in large part, on the assumed growth rates in
the U.S. and the expected yields from U.S. government paper.
With the U.S. dollar down some 7% on a trade-weighted basis
since the beginning of the year, one wonders if foreigners
(mainly Asian governments) can and will continue to fund the
U.S. economic engine and indeed as a consequence, lend support
to the dollar.
So where should you put your money given our view that economic
growth will slow in the U.S. over the coming quarter and that
the U.S. dollar will continue to slide against other major
currencies? Our analysis leads us to the following conclusions:
investors are best advised over the next three months to underweight
the U.S. dollar and overweight the U.K. pound and Japanese
Yen. Other currencies that investors might want to overweight
in declining order are the Australian dollar, Swiss Franc
and Canadian dollar. All of these currencies promise greater
upside and less downside risk than holding U.S. dollar denominated
assets.
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