Look for the dollar to continue on a forward march against other developed-markets currencies for at least the next six months, if not longer.
July 29, 2014
By Robert Stowe England
When Mohamed El-Erian speaks, the markets listen. And right now El-Erian, one of the world’s leading bond market voices, is saying that the U.S. dollar is going to rise over the near term against the euro and the yen.
“You would expect — and I do expect — that the global standing of the dollar would be more than it would have been otherwise,” El-Erian says in an interview with Institutional Investor. El-Erian, the recently departed CEO and co–chief investment officer at Pacific Investment Management Co., currently works as chief economic adviser for PIMCO’s parent, the big German insurance group Allianz. His comments draw attention to a quiet dollar rally that has already begun in recent weeks, one that he believes is likely to last through year-end and, by some accounts, should continue through next summer.
“Put another way: Investors will get rewarded more by investing in U.S. dollar interest-bearing assets than in the equivalent in Europe or Japan,” says El-Erian. As a result, funds are flowing into the U.S. to purchase dollar-denominated assets. “There’s a very big differential between the ten-year Treasury rate at 2.50 and the ten-year German Bund rate at 1.15 — that historically is a very large gap.”
The interest rate gap could actually widen in the coming months as U.S. monetary policy starts to diverge more from European and Japanese central bank policy. At the peak of its third phase of quantitative easing a year ago, the Fed was purchasing $85 billion in bonds a month — a pace of $1 trillion a year — but it has been tapering its buying since January. “By October the Fed will have exited quantitative easing entirely,” says El-Erian. “It is signaling the likelihood that rates will start rising in the middle of next year. Compare that to the European Central Bank, which is likely to loosen its monetary policy more in September, October — and the Bank of Japan, where monetary policy will remain ultra-loose.”
Although El-Erian is confident about a further rise of the dollar against the euro, he is less certain about the direction the yen will take against the dollar. Unlike the euro zone, he says, Japan has the ability to repatriate capital readily, meaning that the yen’s trajectory is a little more tricky to forecast. Even so, other observers expect the yen to continue to weaken against the dollar. For example, in a note published July 14, Shusuke Yamada, chief forex strategist at Bank of America Merrill Lynch in Tokyo, predicted the yen would weaken to 108 by the end of the year, “driven by the widening U.S.-Japan yield gap.”
The dollar, which traded at $1.39 per euro on May 7, was trading at $1.34 on July 28, and El-Erian expects it to continue to strengthen, to $1.30 by year’s end. He also sees the dollar appreciating in value against the yen. The dollar has recently risen against the yen, from 101.34 yen per dollar on July 18 to 101.82 yen per dollar on July 28, a modest weakening beyond its steep 34 percent slide from its peak of 75.83 yen to the dollar in October 2011.
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