Go against the grain and take a punt on the buck

Kathleen Brooks
INVESTORS have found plenty of reasons to sell the dollar in recent months, including a terrible fiscal outlook in the US and a central bank that remains wedded to stimulus measures and low interest rates. Added to that list this week was a weak start to the US earnings season after aluminium producer Alcoa reported lower than expected profits in the fourth quarter of 2009.

The prospect that other US companies will follow in Alcoa’s footsteps and disappoint analyst expectations has led to fears that the dollar will experience another leg lower.

But amid all of this gloom, some believe that there are reasons to be optimistic about the outlook for the greenback. Why? Firstly, corporate US earnings might not be as weak as Alcoa’s suggest.

The aluminium producer used to be a bellwether of the corporate world, but as the US economy has shifted from manufacturing to services it is less of a reflection of the health of America Inc. Also, banks such as JP Morgan, Morgan Stanley and Goldman Sachs should show positive growth. If corporate America is strong then the dollar should rise.

Secondly, the dollar could start to move in line with equities this year. The positive correlation between the buck and equities broke down for most of 2009 – when equities rose the dollar fell.

However, in December the dollar rallied alongside equities for the first time in more than a year. Angus Campbell from London Capital Group thinks that this trend will continue, especially if signs of a US economic recovery translate to higher corporate profits.

The third reason for expecting US dollar strength is that if equities do start to drive the performance of the greenback, then the Fed’s reluctance to raise interest rates could actually benefit the dollar. A low interest rate environment is positive news for business as it keeps down borrowing costs, which in turn boosts firms’profits.

Another factor is that the dollar’s position as the world’s reserve currency is looking stronger than it has at any point in the past 18 months.

Central banks might be talking about diversifying their reserves into euros, but the single currency has come under pressure of late as Greece, Ireland and Spain all struggle with sovereign debt problems and credit downgrades. This lack of an alternative should also support the dollar this year.

After a torrid few years for the greenback, Angus Campbell thinks that everyone who is bearish the dollar has already taken out a short position. “With sentiment so low for the dollar now is the time to buy.”

Since the start of this year, the dollar has simply moved sideways but if the banks manage to report strong profits in the coming days and weeks, this could be a good opportunity for foreign exchange traders to take out a long position in the dollar.