The falling dollar

Since the start of the year the dollar has fallen by around 9.3 percent against the other major currencies, declining 15 percent against the British pound and 12.7 percent against the euro. It has also declined an average of 4.8 percent against Asian currencies with the Thai baht and Korean won leading the way.

Recession worries plague the dollar

Last week, the dollar dropped sharply after weak economic data from the US, notably the Institute for Supply Management (ISM) survey of manufacturing conditions which indicated that activity contracted for the month of November – the first time since April 2003. Five out of 10 underlying components of the ISM, including employment, new orders and production showed a decline, indicating a higher probability of a recession in the US economy.

The ISM’s index of manufacturing fell to 49.50 from 51.2, dampening any hopes of a Fed rate hike. Historically, the Fed has never raised interest rates when the ISM has been below 50. Looking ahead, Fed fund futures have already priced in a quarter point rate cut by summer.

Unwinding of carry trades

Massive liquidation out of carry trades has sent the dollar to its lowest in 14 years against the British pound and the lowest in 20 months against the euro and the Aussie dollar. The reason why the British pound is so strong is the fact that if the US lowers interest rates next year, the UK rates will already be at par with US rates, eliminating any carry trade advantage.

Meanwhile in Eurozone, another quarter point hike by the European Central Bank (ECB) to 3.5 percent is widely expected by the market. This will be positive for the euro as it will narrow the carry trade advantage of the US dollar. Prior to the ISM data, the dollar already fell hard following reports that the ECB is willing to tolerate sharp gains in the euro.

Other factors going against the dollar

The short-term outlook is not so good for the dollar. The month of December is usually bearish for the dollar if we take into account seasonality. Over the past 20 years, the dollar has depreciated against the euro for 10 out of those 12 years during the month of December.

The combination of a weaker dollar and a bleaker US economic outlook could also resurrect talks of reserve diversification of central banks. China caused a stir last month by raising the prospect of transferring funds out of dollar assets and into gold. China currently has about a $1 trillion in foreign exchange reserves but gold reserves account for a mere 1.3 percent, far lower than the three percent level seen in most countries.

Peso drifting higher with other currencies

We have been bullish on the peso since last year on the basis of the positive developments in the fiscal sector, the continued inflow of portfolio investments and record BPO revenues & OFW remittances.

This year, however, the Philippine peso (which is up 6.5 percent year-to-date) is just taking its cue from other currencies. In fact, while the peso is trending higher against the dollar, it has either depreciated or stayed neutral against most major currencies. Nevertheless, looking forward, the general weakness of the dollar will continue to be a boon to the peso.

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