Dollar rises to one-month highs

The near two-week old unwinding of dollar-funded carry trades continued on Wednesday, as hawkish comments from the Federal Reserve and rising US inflation pointed to further US rate hikes ahead.
The move spilled over into other major currencies, with the dollar rising to one-month highs against the euro, yen, sterling, Swiss franc and Australian dollar. The dollar rally was aided by the newsflow from Europe, with German business sentiment disappointing and the Bank of England releasing soft minutes. But there was no doubt the rally was made in the US.
Dollar-buying was set in train by the Federal Reserve, which on Tuesday warned that inflationary pressures were building and output growth was “solid”. A raft of analysts warned that the risk to their end-of-year interest rate forecasts, generally in the range of 3.75-4 per cent, was now to the upside.
These sentiments received a further shot in the arm when headline consumer price inflation came in at 0.4 per cent month-on-month in February, with the core rate at 0.3 per cent, both ahead of forecast.
The dollar rally has been most pronounced against high-yielding emerging market currencies, as rising US Treasury yields erode the attractiveness of dollar-funded carry trades, leading to an unwinding of these positions. But on Wednesday the dollar made serious headway against other major currencies.
The dollar broke through the $1.30 barrier against the euro for the first time in five weeks, pushing to $1.2973, a gain of 1.7 per cent since the Fed statement. The greenback also strengthened 0.9 per cent to Y105.94 against the yen, 1.7 per cent to $1.8686 versus sterling, 1.8 per cent to SFr1.1980 against the Swiss franc and 2.6 per cent to $0.7703 against the Australian dollar.
The New Zealand dollar plunged 3.6 per cent to $0.7159 as New Zealand’s current account deficit widened to NZ$3.1bn in the fourth quarter, against expectations for NZ$2.4bn. The deficit equalled 6.4 per cent of GDP in 2004 as a whole.
Sterling slipped to £0.6944 against the euro and Y197.96 against the yen on Wednesday on the back of the minutes of the Bank of England’s last policy meeting.
Despite the Bank’s monetary policy committee voting by a reduced majority of 7-2 against an immediate rate hike, the consensus was that the minutes were broadly dovish.

FED raises US interest rates to 2.75pc

The US Federal Reserve raised interest rates yesterday for the seventh time in a row and said it would continue to tighten monetary policy at "a measured pace". The rise in rates by a quarter point to 2.75pc had been widely anticipated and Wall Street was more focused on the text of the accompanying statement.
Financial markets feared that the phrase "measured pace", which the Fed has consistently used to describe its policy of modest quarter point rises, might have been dropped, indicating larger upward moves could be on the horizon.
The Fed said that "longer-term inflation expectations were well contained" and said that higher oil costs had not yet fed through into core inflation.
Nevertheless, the bank did note that "pressures on inflation have picked up in recent months and pricing power is more evident". It also described the pace of growth as "solid" rather than "moderate". The Fed also noted that the balanced risks assessment to both growth and inflation was contingent on "appropriate monetary policy action".
The dollar jumped higher against sterling and the euro after the announcement, along with Treasury yields.
The yield on the benchmark 10-year note shot up to 4.59pc from 4.48pc just before the announcement, while the Dow Jones Industrial Average was 50 points lower at 10515.
Most analysts believe the neutral level of US interest rates is about 4pc. Bear Stearns is predicting rates of 4.5pc by the end of 2005, a level which would require a 50 basis point rise at some point during the year.
The Fed's unanimous decision came after data released earlier in the day showed US producer prices rising. Wholesale prices rose 0.4pc in February, while the core producer price index rose 0.1pc.
In the UK, inflation measured by the official Consumer Price Index remained at 1.6pc in February, defying expectations of a rise. Faltering consumer demand meant retailers were unable to raise shop prices after the New Year sales by as much as in previous years.

US Dollar up ahead of Fed meeting

The US dollar continued its mini-rally on Monday, buoyed by suggestions that the Federal Reserve could signal a faster pace of monetary tightening when it meets on Tuesday.
The Fed is widely expected to raise interest rates by 25 basis points to 2.75 per cent, but the accompanying statement may be more illuminating, with some banks, such as UBS and Citigroup, suggesting the pace of tightening will no longer be described as “measured”.
While most analysts still expect the word “measured” to be maintained for now, there are widespread expectations of more hawkish language.
With both producer and consumer inflation data due from the US this week, as well as a long weekend looming, speculators have every reason to cut their exposure to risk by continuing to reduce short-dollar positions. The cost of funding short-dollar positions will also become more expensive, assuming the Fed does hikes rates.
After gaining ground for the first time in six weeks last week, the dollar strengthened a further 1.1 per cent to $1.3162 against the euro, 0.3 per cent to Y105.09 against the yen, 0.7 per cent to C$1.2115 against the Canadian dollar, 0.9 per cent to $0.7861 against the Australian dollar and 1.1 per cent to $1.8973 versus sterling, a four-week high, although trading was thin, exacerbated by a public holiday in Japan.
The dollar even withstood comments from Christian Noyer, a council member of the European Central Bank, who said central bank and private sector diversification from the dollar was “under way”.
The euro was under pressure after a decision by EU finance ministers to water down the stability and growth pact which, in theory at least, limited member states to fiscal deficits of 3 per cent of GDP.
ABN Amro said the “euro’s credibility was dealt a blow” by the decision. The single currency fell 0.8 per cent to Y138.31 against the yen.
High-yielding currencies suffered just as badly as speculators continued to unwind the dollar-funded carry trades that had served them so well.
Sterling was weak across the board, falling 0.8 per cent to a four-week low of Y199.44 versus the yen. The speculative sector remains very long sterling-dollar, making the pound potentially acutely vulnerable to the ongoing liquidation of dollar shorts.
Several emerging market currencies saw further weakness as western funds cut exposure amid a further loss of appetite for risk. The new Turkish lira fell 1.4 per cent to a six-week low of TL1.3360 to the dollar, while the Polish zloty and Czech koruna fell 2.4 per cent and 1.6 per cent against the euro respectively, before recovering somewhat to 4.0537 zlotys and Kc29.975.

US, Japan, Germany, France and UK face junk debt ratings

Rapidly rising pension and healthcare spending will reduce the debt status of the world's richest industrialised countries to junk status within 30 years unless their governments move quickly to balance budgets and reduce outgoings according to Standard & Poor's.
The credit ratings agency says if fiscal trends prevail, the cost of ageing populations will fuel downgrades of France, the US, Germany and the UK from investment grade to speculative, or junk, category France by the early 2020s, the US and Germany before 2030 and the UK before 2035. They are currently in the top Triple A category, ensuring they can borrow at low rates.
The debt ratios of these countries are set to reach levels not seen since the second world war, S&P says.
S&P, says: “Without further adjustment either to current fiscal stance or to social and healthcare costs, the general government debt ratios of France, Germany and the US will surpass 200 per cent. This will result in deficits more akin to those associated with speculative grade sovereigns.”
All big industrialised nations face the problem of large unfunded pension liabilities and rising healthcare costs as populations age. Most have responded with limited moves to make benefits less generous. But S&P's projections already factor in the reductions in public sector pensions made by Germany and Italy last year.
The agency estimates that according to current trends US general government debt will soar to 239 per cent of gross domestic product by 2050, against 65 per cent today. France's will reach 235 per cent against 66 per cent, Germany's 221 per cent against 68 per cent, and the UK's 160 per cent against 42 per cent. Italy, which has run more disciplined budgets because of its already-high debt burden, will see its ratio fall to 91 per cent from 104 per cent, assuming it maintains the current trend. S&P said last year the debt ratio of Japan, the most heavily indebted industrialised country, was set to surpass 700 per cent of GDP by 2050.
The agency's model shows countries can ease the impact of ageing by running tight budgets before demographic pressures peak. The US has healthier demographic trends than Europe but its budget deficit will add to the pain when population ageing accelerates about 2020.