FinancialAdvisor's College Class (FACC)

[FinancialAdvisor]

UBS, Deutsche Bank, Merrill Predict Dollar to Decline (Update4)

UBS, Deutsche Bank, Merrill Predict Dollar to Decline

April 8 (Bloomberg) -- UBS AG, Deutsche Bank AG and Merrill Lynch & Co., three of the biggest traders in the $1.9 trillion-a -day currency market, predict the dollar will resume its decline by year-end, according to a Bloomberg survey. Morgan Stanley and Credit Suisse First Boston say they're wrong.

The dollar will weaken to $1.35 per euro at Dec. 31 and 99 yen, based on the median forecast of 49 traders, strategists and investors. The U.S. currency had its best quarterly performance since 2001 against the euro and yen in the three months ended March 31, rising 4.5 percent and 4.4 percent respectively.

The dollar's rally will end as investors shift their focus from rising interest rates to the near record U.S. trade deficit and a current account shortfall that's at an all-time high, said Trevor Dinmore, vice president of foreign-exchange strategy at Deutsche Bank in London. The U.S. currency, which fell for three straight years through December, rose to $1.2826 per euro at 9:40 a.m. in London, from $1.2857 late yesterday in New York. It was also at 108.71 yen.

``We've been dollar bears for the last three years and we're holding that view,'' Dinmore said in an interview. ``On the trade side, we're likely to see a larger deficit over the coming months.'' The current account gap widened to $187.9 billion in the fourth quarter.

Deutsche Bank is the world's second-largest currency trader according to a May 2004 survey by Euromoney magazine. It had the most bearish forecast for the dollar against the euro, predicting it will drop to $1.43 by year-end. The Frankfurt-based bank expects the dollar to decline to 93 yen.

Bloomberg's currency survey was conducted between March 29 and April 6.

Only Temporary

The U.S. currency's advance against the euro in the first quarter recouped more than half of the 8.2 percent slide in the previous three months. It also gained versus the yen as the Federal Reserve raised its target interest rate for overnight loans between banks to 2.75 percent on March 22, the seventh consecutive increase, and said inflation pressures are mounting.

``Higher interest rates can support the currency temporarily, but in the presence of a growing current account deficit we continue to think the dollar will decline'' said Alex Patelis, head of G-10 currency strategy in London at Merrill Lynch.

Merrill Lynch, the world's biggest securities firm, was the second most accurate overall forecaster of exchange rates in the fourth quarter, according to Bloomberg calculations. The New York- based company predicts the dollar will weaken to $1.36 per euro by year-end, the same forecast it made three months ago.

`Corrective Stage'

The dollar's rally from a record low of $1.3666 per euro on Dec. 30 is just ``a corrective stage rather than a turn in the trend,'' said Mansoor Mohi-Uddin, head of currency strategy at UBS in London. ``Deficits are still an issue and mean long-term players aren't willing to buy dollars, such as central banks, private clients and asset managers.'' He projects the dollar will weaken to $1.40 versus the euro and 105 yen, the same call he made at the conclusion of 2004.

Zurich-based UBS, Merrill Lynch and Deutsche Bank together account for 28.1 percent of the global currency market, according to Euromoney's May survey. The Bank for International Settlements estimates the foreign exchange market grew 36 percent the three years to 2004.

The dollar's rally in the first quarter surprised Merrill Lynch, which predicted in late December that the dollar would weaken to $1.39. UBS and Deutsche Bank estimated the euro would end March at $1.36 and $1.35 respectively, from $1.3554 on Dec. 31.

Widening Deficit

The current account deficit widened to 5.7 percent of gross domestic product in the final three months of last year, the most ever, the Commerce Department said on March 16. The gap, which set a record every quarter in 2004, means the U.S. has to attract $1.8 billion a day to maintain the value of the dollar, according to Bloomberg calculations.

The dollar will still break a three-year losing streak should the median average forecast in the Bloomberg survey prove correct. The Fed's Trade-Weighted Major Currency Dollar Index has gained 3.2 percent so far this year. A fourth annual drop would be unprecedented since the collapse of the Bretton Woods system of fixed exchange rates more than three decades ago.

Bears should worry less about the current account deficit and more on the slowdown in the Japanese and European economies, said Stephen Jen, head of global currency research in London at Morgan Stanley, the world's second-largest securities firm.

`Lot of Momentum'

The U.S. economy expanded at a 3.8 percent annualized pace in the fourth quarter, compared with 0.5 percent in Japan. The 12- nation euro region grew 0.2 percent at a quarterly pace in the three months through December. The European Union, which on April 5 cut its 2005 growth forecast, doesn't release annualized figures.

``Traders are taking the softness of the European economy more and more seriously,'' said Jen. ``The U.S. data is still positive and the U.S has a lot of momentum behind it.''

Japan's currency has lost 4.5 percent and fallen to a five- month low versus the dollar since March 14 as government reports showed a drop in factory production and household spending, an increase in unemployment and waning business confidence. The world's second-largest economy grew in the fourth quarter, emerging from the fourth recession since 2001.

`Found a Bottom'

Morgan Stanley predicts the dollar will strengthen to $1.26 per euro by year-end, a level unseen since October 2004, and 98 yen. At the end of last year, Jen projected the euro would close 2005 at $1.32 and Japan's currency would gain to 92 per dollar.

``The dollar looks to have found a bottom against the euro and the yen,'' said Lara Rhame, a currency strategist in New York at Credit Suisse First Boston. ``Interest rates are getting so good, they're getting hard to ignore.''

Rhame, a former Fed economist, predicts the dollar will finish the year at $1.17 versus the euro and 106 yen. Three months ago, the firm's estimate was $1.30 and 100 respectively.

The gap between 10-year U.S. Treasury notes and German bunds of similar maturity has widened to the most since 2000. The spread was 97 basis points late on April 7, up from 53.7 on Dec. 31 and no difference in September. The difference with 10-year Japanese government bonds was 306 basis points from 277 at the end of last year and 257 at the start of December. A basis point is 0.01 percentage point.

UBS's Mohi-Uddin said he's not prepared to change his call on the dollar until foreign investors increase purchases of U.S. assets. UBS clients were net sellers of U.S. stocks in February and March, said Benedikt Germanier, a currency strategist in the bank's Zurich office.

Demand for Securities

A U.S. Treasury Department report on March 15 showed foreign investors purchased a net $91.5 billion in Treasury notes, corporate bonds, stocks and other financial assets, in January, up from $60.7 billion in December. Figures for February are published on April 15.

U.S. stocks have trailed their German and French counterparts since the year began. The benchmark Standard & Poor's 500 Index is down 2.5 percent this year. Germany's DAX Index, by comparison, is up 2.7 percent, while the French CAC 40 Index has climbed 7.3 percent.

``What we're not seeing is real money going back into the U.S.,'' Mohi-Uddin said. ``The fear of high U.S. interest rates is causing traders to unwind short dollar positions, but not put on long dollar positions.'' A long position is a bet on a gain in price, and a short bet benefits from a decline.

``If we see new flows and new positions in favor of the dollar, this will make us think again about our view,'' he said.

To contact the reporters on this story:
Jake Lee at [e-mail]

To contact the editor responsible for this story:
Daniel Moss at [e-mail].


LINK: http://www.bloomberg.com/apps/news?pid=10000085&sid=aixRvTALpSOs&refer=europe