Even Currency Traders Are Scared

Dollar's Moves Force Whispers of `I' Word; G-7 Frets (Update3)
By Gavin Finch

March 24 (Bloomberg) -- For the first time in 13 years, people who trade currencies say confidence in the markets to determine exchange rates is dwindling.

The crisis that may bring the so-called Group of Seven nations to coordinated intervention is the result of a sinking U.S. economy, the weakest dollar since 1971 and the biggest currency fluctuations this decade.

``The risks of coordinated intervention are going to increase in the second quarter for sure as the dollar weakens further,'' said Mitul Kotecha, head of foreign-exchange research in London at Calyon. The firm is the securities unit of Credit Agricole SA, France's second-biggest bank.

Even with the latest gain against the euro, strategists at Deutsche Bank AG in Frankfurt, the world's biggest currency trader, say the dollar is likely to fall to $1.60 versus Europe's common currency, from $1.5428 as of 7:49 a.m. in New York, because of a recession. Royal Bank of Scotland Group Plc, the fourth-largest trader, says the risk of intervention is increasing and ``would become severe'' if the dollar depreciates below $1.60.

``The strength of the recent euro-dollar rally came as a surprise to many people, and such swift moves certainly raise the specter of coordinated central bank intervention,'' said Hans-Guenter Redeker, global head of currency strategy in London at BNP Paribas SA, the most accurate forecaster in a 2007 Bloomberg survey. ``As volatility rises, the likelihood of such an intervention increases.''

`Disorderly Movements'

After the Federal Reserve's U.S. Trade Weighted Major Currency Dollar Index declined to 69.2631 on March 18, the lowest in 37 years, Redeker said he sees parallels between now and 1995. That was last time central banks stepped in to arrest a slide in the greenback by purchasing and selling currencies to influence exchange rates.

The most obvious is implied volatility on options for the dollar, which rose to 14.5 percent last week, the same as in 1995 and up from the low this year of 9.62 percent on Feb. 26. Morgan Stanley is on ``intervention watch,'' Stephen Jen, the New York-based firm's head of foreign exchange research, said March 14.

The G-7, which comprises the U.S., U.K., Canada, Japan, Germany, France and Italy, said Feb. 9 that ``excess volatility and disorderly movements in exchange rates are undesirable.'' The group next meets April 12-13 in Washington.

Volkswagen Avoids U.S.

Finance ministers and central banks object to rising volatility because it complicates the assessment of economies, interferes with monetary policy and gives companies little time to adjust by cutting costs.

Peter Loescher, the chief executive officer of Siemens AG, Europe's largest engineering company, said March 4 the current level of the euro is ``not easy'' for the Munich-based company. Wolfsburg, Germany-based Volkswagen AG, Europe's largest carmaker, said March 3 that it won't sell its new Scirocco sports hatchback in the U.S. because of the dollar's decline.

The slump has accelerated since February, raising concern that international investors will avoid U.S. financial assets, making it harder for the Treasury to fund a growing budget deficit. Net sales of U.S. stocks and bonds by private foreign investors totaled $38.2 billion in January, the most since September, the Treasury Department said March 17.

While the dollar rose last week against the euro for the first time since the period ended Feb. 7, increasing 1.44 percent to $1.5448, it has fallen from $1.4365 on Jan. 22. It was little changed versus the yen, ending at 99.46. The dollar is below 100 yen for the first time since 1995 and last traded at 99.80 yen.

Watch the Yuan

For clues to when officials may intervene, watch the euro's performance against the yuan, Adrian Schmidt, senior currency strategist in London at Royal Bank, said in a March 17 research report. The yuan fell to 11.2639 per euro last week, approaching its record low of 11.3076 in December 2004.

If the euro reaches a new high, ``the probability of coordinated intervention'' on the dollar ``certainly increases,'' Schmidt wrote. The bank's analysis also shows the dollar is as weak now versus the euro as it was at the end of 2004.

The comparison to 2004 is important, Royal Bank says, because central banks cut back on their euro-denominated reserves after a big increase in the fourth quarter of 2004 and a rally in Europe's common currency, setting the stage for the dollar to appreciate.

Dollar Benefits

International Monetary Fund data show that official foreign exchange reserves denominated in the euro rose 0.9 percentage point in the final three months of 2004 to 26.4 percent. By the end of 2005, it fell to 24.1 percent, while the percentage for the dollar rose to 66.9 percent from 65.8 percent. The U.S. Dollar Index surged 12.8 percent that year, the biggest gain since it rose 13 percent in 1997.

An effort to boost the dollar may not be imminent, according to Mansoor Mohi-Uddin, head of currency strategy at Zurich-based UBS AG, Europe's biggest bank.

The depreciating dollar has made U.S. goods cheaper to foreigners. Exports climbed to a record $148.2 billion in January, the Commerce Department said March 11. A strong euro may help the European Central Bank contain inflation, which is at a 14-year high. And the yen is still about 40 percent weaker than its 1995 peak on a trade-weighted basis.

``America, Japan and Europe all still have good reasons for now to eschew intervention,'' Mohi-Uddin said in a research report dated March 18.

Stepping Up Rhetoric

The G-7 may find it politically difficult to support the dollar after lobbying China since 2000 to stop meddling in the foreign-exchange markets. China controls the yuan by buying foreign currency to limit the dollar's rise, a strategy which has led to accusations from the European Union and U.S. that it's keeping the currency undervalued.

``We've had four years of G-7 policy makers encouraging China to intervene less, so its going to be a bit difficult for them to intervene themselves,'' said Jim O'Neill, head of global economic research at Goldman Sachs Group Inc., the most profitable securities firm.

Policy makers have stepped up their rhetoric to break the dollar's slide. ECB President Jean-Claude Trichet said March 10 he's ``concerned'' by the euro's climb against the dollar, while European leaders meeting at an EU summit in Brussels on March 14 said ``disorderly'' currency moves are ``unwelcome.'' Japan's Finance Minister Fukushiro Nukaga said March 18 the dollar's 9 percent decline in the previous four weeks was ``excessive.''

Supporting the Euro

``I'm worried about the talk we continue to hear from European and Japanese politicians which suggests that they are becoming increasingly concerned about the impact the weak dollar is having on their economies,'' said Simon Derrick, head of currency strategy at Bank of New York Mellon Corp. in London. ``We may be heading toward coordinated intervention.''

The G-7 hasn't acted together since September 2000, when they supported the euro after it dropped as low as 82.30 cents. The last time there was any action on the dollar was when it sank as low as 79.75 yen in 1995, sparking an 81 percent gain against Japan's currency the next three years.

The slumping dollar forced the Bank of Israel to buy foreign currency for the first time since 1997, it said March 13, causing the shekel to pull back from an 11-year high. Brazil's government imposed a tax on foreigners' purchases of local debt after the real appreciated 62 percent the past three years.

South Korean authorities will take preemptive measures if necessary to counter any ``drastic'' movements in the won, Vice Finance Minister Choi Joong Kyung said March 19.

To contact the reporter on this story: Gavin Finch in London at gfinch@bloomberg.net