Forex outlook: mortgage bailout plan may support dollar next week

21 Sep, 2008

The dollar may rise next week amid hopes a US government plan to contain the credit market crisis that is threatening the country's banking system will bring relief to wobbly global markets. But details associated with the plan, which could cost hundreds of billions of dollars, also pose a risk to the US currency, especially given concerns about the widening budget deficit, analysts said.
The plan could also revive risk appetite and in the near-term reduce some of the safe-haven trades that had boosted the dollar, they said. "There are some rumours that Congress will attach some new spending bills to it as well. The dollar is now much more exposed to event risk," said Marc Chandler, head of global currency strategy at Brown Brothers Harriman in New York.
Treasury Secretary Henry Paulson on Friday called for a "decisive" asset relief plan to remove illiquid mortgage assets from the balance sheets of banks, which are blocking the financial system. The move follows this week's collapse of investment bank Lehman Brothers Holdings, the acquisition of Merrill Lynch by Bank of America and the US government's bailout of insurer American International Group.
"If there are concrete signs at the weekend or coming days that Congress is going to approve of the plan that the Treasury is working on, it could provide some support for the dollar," said Samarjit Shankar, global FX strategist at the Bank of New York Mellon in Boston.
"For now, we would advise investors to have a more neutral stance on the dollar going forward simply because there are a lot more risks right now. As a result we are seeing commodity and gold prices beginning to recover and some flows into the euro, the Canadian and Aussie dollars."
Data next week, which includes final second-quarter figures, housing statistics and durable goods orders, will be of little significance, with the focus remaining firmly on the financial market, analysts said. The euro surged to a two-week high versus the dollar around $1.4541 on Thursday. It rose again on Friday, with investors putting money back into carry trades amid optimism over the government's plan to mop up assets made illiquid by the mortgage debt crisis.
The dollar has rallied since August as US-based investors, worried about slowing global economic growth, liquidated their positions in foreign stock markets and repatriated the money back home.
CONSOLIDATION ON CARDS: That caused the euro to slide from its record high above $1.60 touched in mid-July to as low as $1.3882 last Thursday, according to Reuters data. Given those strong gains, analysts reckon it's time for the dollar to consolidate before resuming its upward trend. "The outlook is dollar-negative, but within a bull market. The dollar is going to be set back a little bit," said Brown Brothers Harriman's Chandler.
"The first leg of the dollar's rally is over and we are now facing a period of consolidation until we get the second leg." Chandler noted that technical factors are also against further dollar strength in the near term, pointing out that the euro tested its 22-day moving average since late July, while the pound's five-day moving average was above its 22-day moving average.
"The next leg up for the dollar I anticipate would be driven by a more optimistic outlook about the US economy and Fed tightening. That may not take place until the end of the first quarter next year," said Chandler.
Others agreed and BNP Paribas strategist Paul Mortimer-Lee argued that the big dollar-supportive themes, namely investors pulling out of peripheral markets, still exist. "Unprecedented gross cainto emerging markets witnessed over recent years is now determining the magnitude of the liquidation risk," Mortimer-Lee said in a note.
"Although all major currencies will benefit from investors' withdrawal of assets from emerging markets, the dollar will benefit the most as the US unit has been primarily used as a funding currency, especially in Asia and Latam."

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