Dollar Down So Long Looks Like It's Going Up

Dec. 7 (Bloomberg) -- Just when bellyaching about the weak dollar is reaching a crescendo, the U.S. currency is showing signs of redemption.

To be sure, the dollar isn't about to perform as if it suddenly received a dose of Viagra, and a bullish reversal of its multiyear decline is probably several months away.

Still, improving U.S. trade, damage from a weak U.S. economy spreading to other countries, the prospect of lower interest rates in Europe and overwhelming disenchantment with the dollar's decline suggest the U.S. currency is about to stop falling -- if it hasn't already.

``Forecasts of a dollar rebound in 2008 are becoming more frequent as the U.S. current account and budget deficits continue shrinking,'' says Ashraf Laidi, New York-based chief foreign- exchange analyst at CMC Markets.

After climbing to a record $1.4967 on Nov. 23, the euro has retreated to about $1.46 in late London trading yesterday, indicating that some of the steam may be coming out of the currency used by 13 European countries. Ditto the U.K. pound, which traded at a 26-year peak of $2.1161 on Nov. 9, but has since dropped back to $2.03.

The dollar has fallen 44 percent against the euro in the past seven years; so far in 2007, it is down 9.8 percent against the European common currency. Adjusted to reflect U.S. trade with other countries, the dollar has sunk 23 percent since February 2002 and 8 percent this year.

The U.S. currency is key to global corporate competitiveness, company profits, the price of gold and other commodities and world equity-market performance.

`No Choice'

Yet dollar sentiment is still stunningly negative -- so much so that the pessimism is music to a contrarian's ear.

On the corporate front, Louis Gallois, chief executive officer of European Aeronautic, Defence & Space Co. said on Dec. 3 that the weak dollar left his company ``no choice'' but to shift some production to the U.S. and other countries linked to the American currency. Two days earlier, French military and business-jet maker Dassault Aviation SA said it was considering similar moves.

In late October, billionaire Warren Buffett, the CEO of Omaha, Nebraska-based Berkshire Hathaway Inc., reiterated his disaffection for the U.S. currency. Six days later, Bill Gross, chief investment officer of Pacific Investment Management Co. in Newport Beach, California, said, ``We've told all of our clients that if you only had one idea, one investment, it would be to buy an investment in a non-dollar currency.''

Economist's Warning

The cover of the Nov. 29 edition of the Economist magazine shows a $1-bill likeness of George Washington portrayed as a World War I pilot in a burning plane about to crash. ``The panic about the dollar,'' reads the headline.

The Economist cover ``is a classic warning sign that a trend change is near,'' says David Abramson, Montreal-based head of currency strategy at BCA Research Ltd.

From a more fundamental perspective, the weak dollar has fueled U.S. export growth and shrunk the trade deficit to $56.5 billion in September this year from a record $67.6 billion in August 2006. The shortfall in the current account, a broad measure of trade in goods and services plus certain financial transfers, has narrowed to 5.8 percent of U.S. gross domestic product from a record 6.3 percent last year.

Meanwhile, the American disease -- a weak currency, slowing growth, reduced domestic spending and rising credit costs -- is spreading, discrediting the theory that other countries were strong enough to ``decouple'' from the $13 trillion U.S. economy.

European Slowdown

Consumer confidence in the euro area, U.K. and Japan is slumping. European GDP growth in the third quarter fell to 2.7 percent from a year earlier compared with 3.3 percent in the last three months of 2006; industrial production dropped in September and strengthening European currencies are starting to eat into exports. Retail sales in Germany, Europe's biggest economy, declined 3.3 percent in October from September.

The U.K. economy is vulnerable to tighter credit conditions, deteriorating global growth, the eventual impact of sterling strength on exports and a long-anticipated slowdown in housing. Service-industry growth is the slowest since May 2003. U.K. house prices fell for the third consecutive month in November, the worst performance since 1995.

``The extent of the dollar rebound will largely depend on the scope of interest-rate cuts in Europe, Canada and Australia, serving as an offset to further rate cuts by the Federal Reserve,'' Laidi says.

Rate Reductions

Britain lowered rates yesterday, preceded by Canada two days earlier. Meanwhile, the U.S. has already cut its benchmark to 4.50 percent from 5.25 percent, and further reductions are priced in. Traders are betting there is a 58 percent probability the Fed will cut its federal funds rate to 4.25 percent on Dec. 11 and a 55 percent chance of a reduction to 4 percent on Jan. 30, according to futures contracts.

``The euro could easily trade back below $1.40 over the next couple of months,'' Abramson says. Laidi, who has a similar euro view, sees sterling retreating to $2.01 before year end.

The euro will trade at $1.46 in the first quarter of 2008, according to the median forecast of 41 institutions surveyed by Bloomberg, while the median projection of 39 analysts puts the pound at $2.04.

Unfortunately, those exchange rates won't quell the complaints, especially if a dollar rebound is more the product of negative news abroad than solid domestic growth and dynamic financial markets in the U.S.

(Michael R. Sesit is a Bloomberg News columnist. The opinions expressed are his own.)