Despite its fiscal weakness, dollar remains attractive

Kathleen Brooks
THE US dollar has staged an impressive rally against the euro and sterling. The US is benefiting from safe haven flows as investors ditch the euro over fears of a sovereign debt crisis for Greece that could spread to Portugal, Spain and even to the UK.

But are the US’s finances actually any better than European countries’? The US Congressional Budget Office (CBO) estimates that the US budget deficit will top a massive $1.3 trillion this fiscal year, the equivalent of 9.2 per cent of GDP.

The US is firmly in the high deficit category. Its shortfall is roughly the same as Portugal and although the US finances are not in quite as bad a state as they are in Spain, Greece, and the UK, it still has a mountain to climb to get its finances back on track. So should the dollar be a sell, as those countries’ currencies are?

No. For now, investors are ignoring the US’s fiscal baggage, and they should continue to do so. In fact David Woo, FX strategist at Barclays Capital, thinks the dollar will continue its upward trend. He revised up his forecasts for the US dollar for the next six months to $1.35 against the euro.

He cites three reasons for dollar strength. First, the rise of the Republicans in recent months has shifted the political landscape in the US, most notably when they took the Massachusetts Senate seat, which had long been held by the Democrats. Growing Republican influence could create a more fiscally conservative stance in the US, which is dollar positive, says Woo.

Second is the prospect that the Federal Reserve will terminate its asset purchase scheme. The US economy continues to show signs of strength. Removing stimulus is another form of tightening, which should benefit the US dollar.

Lastly, Woo says that supports for the euro have been damaged by Greece and Portugal’s debt crisis. The euro benefited against the dollar in recent years because central banks, particularly in emerging markets, tried to diversify their reserves into the single currency. As fears grow that there could be a sovereign debt crisis in Europe, there will be fewer euro buyers, a third dollar positive fact.

So, although the US faces years of high deficits, it looks relatively stable compared to Europe and the UK. For this reason, until things settle down the other side of the pond, the US dollar is a buy.