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The Expectations of the Dollar - Essay Example

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Summary
The dollar declined for a fourth day against the yen and Euro after a report showing slower-than- expected inflation eased speculation that the Federal Reserve will raise interest rates more than twice this year. The dollar has fallen more than 2 percent against the euro and more than 1.8 percent versus the yen the week ending Mar 16, the biggest drops since the week ended Jan…
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The Expectations of the Dollar

Download file to see previous pages... Interest-rate futures demonstrate that the traders are certain the Fed will increase its benchmark to 4.75 percent on March 28, and predict about a 65 percent chance of another increase to 5 percent at the May meeting. However the outlook was not the same say in October 2005 when Fed was expected to go in for graduated dosages of increase in interest rate in keeping with the trend began since June 2004. The dollar had then risen 2.3 percent against the yen since the end of June 2005. The dollar ran its third straight quarterly gain, reported in October 2005, against the yen, the longest winning streak since 2001, as the Federal Reserve stuck to its policy of ''measured" increases in interest rates. The markets had then expected the dollar to rally to about 115 yens. The yield advantage of 10-year US Treasury notes with Japan had averaged 2.87 percentage points in 2005 year and reached as much as 3.27 percentage points on March 28 2005. As a result of these Japanese investors were buying the dollar to purchase overseas assets, such as Treasuries strengthening interest in dollar. As compared to this The Bank of Japan had kept rates near zero since 2001.US Rate increases had helped notch an 11 percent gain in the dollar vs. the yen. However for the first time ,in this scenario Bank of Japan indicated that the yen may be supported by indicating a timetable for ending its policy of holding interest rates near zero.BOJ had also decided to stop pumping money into the economy and to recommence forecasting of inflation after a seven-year absence.
The risks to the US dollar in 2006 are being widely debated. Last year too Bill Gates, Warren Buffett and George Soros had predicted a crash of the US dollar which, however, did not materialize. However sufficient arguments exist today on why the US dollarwill stopdefying gravity and fall this year. As stated abovein the last few weeks the dollar has kept on falling relative to the Euro and Yen, as expectations of relative short term interest rate differentials and growth rates are turning against the U.S. US slow down, which may or may not trigger global slow down, is quite a probability with risks of a disorderly adjustment triggered by the bursting of the US housing bubble and the stagflationary effect of another oil shock driven by supply tightness and a confrontation with Iran. Moreover a large trade deficit of 7% of GDP has led to an unsustainable accumulation of net foreign liabilities (Roubini, 2006). These combined with domestic slowdown leave out weak signals for dollar with slight corrections in or around the two expected step-ups. This outlook would run concurrently to the period required to smoothen out these imbalances. This is expected to last the entire of the remainder portion of 2006 at the least.
Theoretical Setting
Post Bretton Woods period was a period of fixed exchange rates and primary forex market analytics concerned the effects of discrete policy induced changes in the level of exchange rates-be it a devaluation or appreciation. National economies and the global economy as result ...Download file to see next pagesRead More
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