and Dollars Euros: A Look Beyond the Parity Line
November 10, 2002 Dollars and Euros: A Look Beyond the Parity Line By JONATHAN FUERBRINGER he dollar is now worth less than a euro, and currency analysts say it has even further to fall. They predict that American tourists may be paying $1.05 for a euro next summer, and $1.10 at the end of 2003. If that view is right, Americans invested in stocks or bonds in Europe would enjoy a welcome windfall. The dollar's 12.2 percent decline against the euro this year has already been very good to them, reducing losses in stocks and increasing gains in bonds when these performances are translated back into dollars. But investors should not accept the forecast as a fait accompli, because a further fall in the dollar depends on continuing weakness of the American economy. The dollar fell to below parity with the euro last Wednesday, after the Federal Reserve cut interest rates, and some traders and investors apparently viewed the Fed's move as a sign of more months of slow growth. The dollar finished the week at $1.01TK to the euro, almost a three-year low. A growth surprise, however, could give the dollar a boost. And the Fed's aggressive half-point rate cut makes it more likely that the economy could spurt ahead faster than expected next year. The dollar also fell to parity with the euro in July but then rallied, confounding predictions of further declines. Stephen S. Smith, who manages a $2.5 billion global bond portfolio at Brandywine Asset Management, said he decided in July to hedge his European bond portfolio against a dollar rally. Now he is preparing to drop that hedge and benefit from a falling dollar if the American currency slips a little lower. "We may give way to a weaker dollar and a stronger euro next year," he said. What is strange about the dollar's fall and why it could reverse is that investors are not buying euros because the economic outlook on the Continent is better than it is in the United States. In fact, the 2003 forecast for the 12-country euro zone shows slower growth than in the American economy. Instead, the dollar is being undermined by disappointment in American performance. never "I see anyone buying the euro because they are excited by the prospects for euro growth," said Lara Rhame, senior foreign exchange economist at Brown Brothers Harriman. "It is just they have found a reason to sell the dollar." Both Ms. Rhame and James McCormick, global head of foreign exchange strategy at Lehman Brothers, said disenchantment with the dollar is centered on forecasts that the American economy will grow about 2.5 percent next year. That is below what economists call the potential growth rate the fastest pace at which the economy can expand without creating inflationary pressures. Because workers' productivity is high, the rate of potential growth is 3 percent to 3.5 percent, these analysts said. The other drag on the dollar, Mr. McCormick said, is the huge size of the American current account deficit, which could reach a record $500 billion this year. When the economy is perking along and foreigners like the stock market, the American economy can attract the investment it needs to cover this deficit. Now, Mr. McCormick said, the dollar is under significant pressure because
the economy "is growing under potential, and that means it is going to be hard to attract the capital to fund the current account deficit." When foreign capital is scarce, interest rates will rise and the dollar will fall to attract more foreign investment. But both Ms. Rhame and Mr. McCormick have caveats, so it may be riskier than it looks to jump into funds promising additional gains from a fall in the dollar, as well as from picking the right stocks or bonds. Ms. Rhame is expecting a 10 percent decline in the dollar in 2003, but she said that "if we return to potential growth next year, the euro is not going to rally." Mr. McCormick expects the dollar to fall to a range of $1.05 to $1.10 to the euro in the next six to nine months. But, he added, "if the United States economy can surprise on the upside and get back to potential in 2003, we should get back to the parity range" on the dollar. That is where it is right now.
Copyright The New York Times Company | Permissions | Privacy Policy