Dollar investors looking to US trade data for clues to the greenback's direction will be disappointed if history repeats itself. The outlook is for the dollar to decline further despite any improvement in the nation's current account deficit, of which the trade deficit is more than 90 percent. The dollar had been helped in recent days by Federal Reserve Chairman Alan Greenspan's turn last Friday to an optimistic view of the US trade deficit. Though the dollar index has since surrendered gains and is flat on the week, it did gain as much rose 1.6 percent in the days after Greenspan's speech.
But based on observations since the dollar was freely floated in 1973, it will take almost a year for the dollar to rally after the US current account deficit begins to narrow. During that time, the dollar could slide another 10 percent.
There's a long term cycle in play wherein the market loses faith in the dollar because of the large imbalances, like the twin US fiscal and current account deficits. The resulting decline in the dollar helps cure those imbalances, said Anthony Chan, managing director and senior economist at JPMorgan Fleming Asset Management.
"It is precisely this phenomenon that makes foreign exchange markets more comfortable with the dollar and eventually lead to a higher value of the US dollar."
However, Chan's research found that in the periods since 1973 when the current account deficit has declined as a percentage of U.S gross domestic product by 1 percentage point or more, the Federal Feserve's major dollar currency index continues to decline for an average of more than nine months before beginning to strengthen.
A year after the current account deficit began to improve, the dollar was down an average 9.2 percent on average, and two years after the current account troughed the dollar was still down 5.1 percent.
The current dollar drop, 28.4 percent in the Fed's major currency index from early 2002 through to the third quarter of 2004, has paralleled a widening in the current account deficit as a percentage of gross domestic product from -4.1 percent to -5.6 percent. But Fed chairman Greenspan told the Group of Seven finance minister meeting in London last Friday that market forces may be about to stabilise the US current account deficit, and he said that the White House was beginning to come to grips with the government's fiscal deficit.
"The current account story will lose the force it had in 2004, but it is still in the background and still wide," said Jeremy Friesen, senior currency strategist at RBC Capital Markets in Toronto.
Some investors may be heartened by Thursday's report from the Commerce Department that indicated the trade deficit had narrowed to $56.4 billion in December from a revised $59.3 billion in November, though the trade deficit for the whole of 2004 reached a record $617.7 billion.
Yet few investors are willing to say the trade gap, the main component of the current deficit has troughed. Some analysts reckon the trade deficit would have to narrow for three or four consecutive months to send a clear signal that the gap was trending narrower. All of which means while it may be just a matter of time before the recent drop in the dollar leads to a sustained reversal in the current account deficit, historical data indicates a rebound in the dollar is a lot further out.
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