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Forward forex markets are bearish for the dollar's status

A QUICK glance at the usually lively currency markets would suggest that not a whole lot is going on in foreign exchange. Major currency pairs are stuck in tight trading ranges &ndash; the euro-dollar, for example, has been stuck in the $1.33-$1.44 trading range since June. <br /><br />It would be tempting to say that traders ought to give up trying to trade currencies, and move into the more exciting equity and commodity markets.<br /><br />But to focus on the spot market is to miss the real drama. &ldquo;The action with the US dollar has been playing out, rather spectacularly we think, in the less glamorous long-dated forward market,&rdquo; says Barclays Capital analyst David Woo. <br /><br />Over the past six months, the 10-year euro-dollar forward rate has been rising, moving from $1.19 in the beginning of March to $1.53 in August. This places the pair within striking distance of the all-high time of $1.59 traded in July 2008. So why are investors becoming so bearish about the US dollar in the long-term? Woo thinks there are three reasons behind the market&rsquo;s long-term expectations for a weak US dollar.<br /><br />Firstly, the market may fear that inflation will be significantly higher in the US than the Eurozone over the next decade, implying a higher future spot rate. Given how worried investors are about the inflationary potential of the Fed&rsquo;s non-standard monetary policy, this is certainly not unfounded.&nbsp; <br /><br />Secondly, Woo says, the market may be worried about the effect associated with the eventual unwinding of the Fed&rsquo;s large-scale asset purchases when a global recovery is seen as firmly entrenched. This could have a disruptive effect on long-term US interest rates, to which long-term FX forward rates are tied.<br /><br /><strong>RESERVE STATUS</strong><br /><br />Finally &ndash; and most importantly, says Woo, &ndash; the US dollar&rsquo;s reserve currency status has been under threat over the past six months. This was intensified yesterday by comments from the UN Conference on Trade and Development (UNCTAD), which said that the present system, under which the dollar acts as the world&rsquo;s reserve currency, should be subject to a wholesale reconsideration. <br /><br />However, the European Central Bank (ECB) came out yesterday partially in support of the US dollar saying that the euro is unlikely to topple the US dollar as the world&rsquo;s leading currency. But it did remark that the single currency could well reach an equal footing <br /><br />If the dollar were to lose some of its standing as a world reserve currency, diversification into alternatives could eventually drive the dollar lower.<br /><br />With investors still uncertain and concerned about the health of the US economy, particularly in terms of the level of public debt, the status of the US dollar will continue to come under fire as countries question whether it is the right currency in which to hold their foreign exchange reserves. And with this very topic on the agenda at the G20 meeting later this month, speculators will be watching closely for indications that the US dollar&rsquo;s hegemonic status is fading.<br /><br />What&rsquo;s more, as the outlook for the global economy brightens, investors are less concerned about placing their money in safe-haven assets. This would reduce the overall demand for US dollars at the expense of higher-yielding more risky currencies and other assets. <br /><br />With the forward markets suggesting that the US dollar will weaken against the euro as investors doubt its reserve currency status and worry about&nbsp; American public debt, now might be the time to sell the buck on a speculative basis.