Dollar losses initiated in the start of this year when investors lost confidence in U.S. assets and pulled out capital in search of the regions with higher return and low risks

June 24 - 30, 2002

The weakness of U.S. stocks has been a key driver of the dollar's recent falls versus major currencies. Overnight dollar losses initiated in the start of this year when investors lost confidence in U.S. assets and pulled out capital in search of the regions with higher return and low risks.

The performance of major stocks markets since the start of year was recorded poor as the Dow slumped around four per cent, the Nasdaq composite index lost twenty-five per cent and the Standard & Poor's 500 index lost ten per cent as the investors diversified from the U.S. assets. Dollar slides happed after the news that the U.S. retailer Kmart Corp had filed for bankruptcy. Overnight losses both in currency and stocks deepened since after the implosion of the one-time energy-trading giant, Enron Corp. in an accounting scandal, investors have grown wary of how Corporate America reports on its financial health. So, the fallout from the Enron scandal has overshadowed the encouraging news. In the current situation it is very alarming for the United States because the trade deficit has widened to US$31.63 billions in May. And in routine this gap was used to fill by capital inflows towards U.S. assets markets. So, currently the U.S. needs more than one billion dollar capital inflow on the daily basis. On theoretical grounds there is no need to worry about for the United States because any trade deficit below five per cent of the GDP is tolerate-able and the U.S. trade deficit is around 4.5 per cent of the GDP. Meanwhile, another area that is very concern worthy for the United States is persistent built up in inventories. U.S. inventories are building up on shaky consumer confidence that pulling down retail sales and in return also damaging productivity.

Persistent losses in the United States' assets also forced foreign investors to hold capital at their homeland. As Chinese central bank's deputy governor Xiao Gang said that China's demand for euros and euro assets was set to rise as the currency's importance in official reserves grows and private sector demand rises. Subsequently, European Central Bank report showed that portfolio and direct investment in the Euro zone saw a combined inflow of 2.2 billion euros in March, compared with a net outflow of 19.8 billion euros in February. Meanwhile Japanese official announced that after the start of this year Japanese stock appreciated more than U.S. stocks in terms of dollar and data released by Japan's Finance Ministry showed that foreign investors were net buyers of Japanese stocks for the third consecutive month in May.

Dollar losses extended after a bleak U.S. employment data confirmed that the United States is in real trouble. The jobless rate climbed to 6 per cent in April the highest since a matching 6 per cent in August 1994 but later on dropped to 5.8 per cent in May but failed to give any boost to local stocks. The report underscored the gradual pace of improvement in the U.S. labor market but did not give full-throated confirmation to investors that the U.S. economy was back on a solid path. Because on the other hand U.S. failed to create expected number of new jobs as non-farm payrolls showed that only 41,000 jobs were created in May, below estimates of a 58,000 increase. U.S. equities plunged to multiple month lows after this news and also undermined the greenback. At that particular day the Dow Jones industrial average shed 0.36 per cent; the Nasdaq Composite index lost 1.25 per cent; and the S&P 500 stock index, a broader market average, lost just 0.16 per cent.

The U.S. officials are stuck in very confused situations as on one hand government is reiterating for a stronger dollar policy and on the other hand manufacturers are asking for a soft currency in order to boost exports and also to make them competitive in the international market. The U.S. Treasury Secretary Paul O' Neil failed to convince markets over his country's commitment to a strong dollar policy. Testifying before the Senate Banking Committee, he was reluctant to extol the virtues of a strong currency, even though he said there had been no change in the country's commitment to a "strong dollar" policy. O'Neill said he doubted governments could long affect currency values either through rhetoric or by actual market intervention. So, from the current situation it seems that U.S. is stuck in such a situation where can't announce or support weak dollar openly rather behind the scenes they might let the dollar free fall. Getting benefit from this strategy manufacturing sector is picking up as the Supply & Management's gauge of manufacturing activity rose to 55.7 for May, its highest level since February 2,000 and above the market's average estimate of a 55.0 reading. A reading above 50 indicates manufacturing activity expanded. On the other hand U.S. President George W. Bush decided to impose tariffs on a range of steel imports in order to support the local industry. But better than expected manufacturing performance in the United States failed to overshadow manufacturing activity in other regions such as Britain and Euro-zone's manufacturing activity also had crossed the barrier of 50. The signs of improvement in major economic regions are mostly result of steps taken by concerned central banks in the last year. Fed cut its discount rates eleven times to 40 years lows at 1.75 per cent from 6.50 per cent in year 2001, meanwhile Bank of England and European Central Bank also lower their rates to 4.0 per cent and 3.25 per cent respectively in the same tenure. But now Fed has less room to pare its rates as inflation figures have started to pick up and was recorded 0.5 per cent in April from 0.3 per cent in March and was 0.2 per cent in Jan 02. Contrast to this persistent rate cuts by the Fed resulted in terms of better economic growth where growth rate has rose to 5.6 per cent in Q1, 2002 from 1.7 per cent in Q4, 2001. But now the main concern is that either the U.S. economy would be able to sustain its path to recovery or not because the investors' confidence is already had been shaken especially when U.S. economy dipped into the recession in Q3, 2001.

Sterling rose to eight-month high of $1.4755 against dollar and at the same time tested thirty months' lows against the euro in the month of June. The pound fell back a little against the dollar after a surprise downward revision to first quarter U.K. gross domestic product. The Office for National Statistics said GDP was unchanged quarter-on-quarter in the first three months of this year and up 1.0 per cent year-on-year. That compares with previous estimates of 0.1 per cent and 1.0 per cent respectively and average of economists' forecasts for 0.2 per cent and 1.1 per cent growth. UK industrial production jumped a bigger than expected 1.1 per cent in April from the previous month, the first rise for eight months. Separate data showed a global goods trade deficit fell to 2.43 billion pounds, the smallest shortfall since last October.

Sterling crumbled against the euro as sellers were motivated by comments from British Prime Minister Tony Blair and Transportation Secretary Stephen Byers, who said legislation for a referendum could be an issue later this year. For Britain to join the Euro-zone, it would have to see its currency weaken to a level comparable with the euro, which now costs less than a dollar and also has to fulfil the criteria set by the Euro-zone. But nervousness towards UK joining mounted after a newspaper report that Rupert Murdoch might campaign against British entry into the euro. The Financial Times reported that the owner of several top British papers, including the mass-selling "The Sun" and "The Times", said "Vote No" was the message he would like to see spread by his British stable of newspapers.

The most beneficiary currency of this year is the Swiss franc. Overnight its gains were mostly driven by its buying as the safe-haven although a strong franc tended to worry Swiss exporters, who prefer a franc under 1.50 to the euro. The euro has recovered some ground recently, but was holding at about 1.47 francs. So to bring the franc exchange rates with expectable ranges since late March the Swiss National Bank has gradually eased rates set on its near daily repurchase operations. Along with the cuts in repo rates, it also lowered its benchmark target for inter-bank funds on May 2, 02 by 0.50 per centage point, aiming to weaken the franc. Since the May 2 easing, the SNB has targeted a range of 0.75-1.75 per cent for its benchmark, three-month London Inter-bank Offered Rate (LIBOR). LIBOR has held roughly in the middle of the target. But now any blowup in the Middle East or increasing tension between nuclear powers India and Pakistan has tended to ignite franc buying.

The newly born Euro rushed to dollar and set 17-month highs of $0.9506 against the dollar and also set a five-month high in the cross rate of yen on persistent gloom on Wall Street encouraged investors to diversify out of U.S. and into euro zone assets.

Dollar also depreciated to five and half month lows versus Japanese yen to 122.77 levels so, in this way shed nearly 6 per cent in 2002 because of growing doubts over U.S. assets and signs that the Japanese economy may have bottomed out. In Japan, real gross domestic product rose 1.4 per cent in Q1, 02 from the previous quarter versus a median forecast of 1.3 per cent. Annualized, the figure would be 5.7 per cent slightly better than the U.S. economy's 5.6 per cent growth in the first quarter.

Japanese stocks have outperformed U.S. equities by nearly 25 per cent on a dollar basis so far this year, encouraging investors to rebalance their portfolios toward Japan. Tokyo stocks rose to 9-month highs in May. With Japanese stocks enjoying an extended rally this year, the funds flowing into yen assets represent "real money" and not the "hot" speculative flows that can reverse quickly in times of stress. Yen showed no response to the news that Moody's has notched Japan's long-term debt rating whereas Standards & Poors already had downgraded Japan's rating. Japan has virtually no foreign debt and foreigners hold only around five per cent of outstanding Japanese Govt. Bonds (JGBs) so effect might be limited. Another major portion of the economy showed good sentiments as Japan's unadjusted surplus recorded 2.20 trillion yen ($17.12 billion) in March.

Meanwhile, Japanese Prime Minister Junichiro Koizumi expressed concerns about the yen's recent higher side move and warned against market volatility. Concerns mounted that the recent surge in the Japanese currency could derail the country's nascent export-led recovery. So in order to tame yen strength the Bank of Japan physically bought dollars four times and sold yen in the month of May and June.

So, the U.S. needs to sustain its path to recovery backed by investors' confidence both in currency and assets otherwise failure can give way to other currencies to lead rather than greenback in near future.