Why did USD appreciate despite widening trade deficit and weak US market during 2005?
The USA will tick more than $700bn as trade deficit during 2005...its highest till date...and this was the most important reason why market stalwarts like Warren Buffett and currency traders like Deutsche Bank, UBS and Citigroup has a negative view on USD against the likes of Sterling, Euro etc. But to their surprise, USD appreciated against the major world currencies putting all above stalwarts in losses. Mr Buffett lost around $1bn this year being short on USD.
The US’s market has largely underperformed its peers’ (Europe and Japan). The Japan market is up by whooping 40% and the European markets are up on an average of 20% as against a mere rise of 4% rise in the US S&P 500 Index. Though of late the sanguine GDP growth figures did provide confidence to the economy but was not strong enough to give an upward thrust to the market. Despite having underperformed its peers and global markets’ it saw its currency…the mighty USD appreciated against the GBP, Euro and Yen. It appreciated 10% against GBP and 14% against Euro and Yen each during 2005.
One factor was of course the continuous rise in the short term interest rate. The Fed Rate which was at 2.25% at the start of the year 2005 and is now at 4.25% at the end of year. So, to benefit favorably foreign investors invested in the US bonds to enjoy higher yields. But that is in the short term bonds. And this is not that much strong an argument to justify the rise. It made me think other factors which could have played besides the rising short term rate. I did think 2 another equally strong if not more arguments to justify why the USD rise against the global heavyweights. They are:
As written in the article dated 28th Dec. 2005, “Flattening yield curve in the US…why?”, I argued for the lower long term bond yield because of foreigners buying heavily into the US bonds. Because of this there was a huge demand of USD against Euro and Yen, and this can be another factor for the rise.
Another one equally strong argument is the GCC (Gulf Cooperative Council) factor. The GCC include 6 oil exporting countries Saudi Arabia, the UAE, Kuwait, Oman, Qatar and Bahrain. These countries have pegged their currencies against the USD for long. With the rising oil demand and thus the prices, these countries have made their fortunes and have earned around $250 bn during 2005 as oil revenue. Now since these countries’ currencies are pegged against the USD and given the fact that these countries maintain their reserves (which are swelling) primarily in USD, the demand for USD increased for the payment for Oil especially during 2005. So gave another boost to the USD rate.
Hence despite having a record trade deficit (which is set to touch $750 bn for 2005), having been devastated by the most dangerous hurricanes, and the Wall Street legendary Warren Buffet’s not so sanguine view on USD and in fact he is believed to be sitting short on the USD to the tune of $16bn!!! down from $21bn during early 2005…the USD has increased during 2005.
So, the USA should not feel complacent enough…
The US’s market has largely underperformed its peers’ (Europe and Japan). The Japan market is up by whooping 40% and the European markets are up on an average of 20% as against a mere rise of 4% rise in the US S&P 500 Index. Though of late the sanguine GDP growth figures did provide confidence to the economy but was not strong enough to give an upward thrust to the market. Despite having underperformed its peers and global markets’ it saw its currency…the mighty USD appreciated against the GBP, Euro and Yen. It appreciated 10% against GBP and 14% against Euro and Yen each during 2005.
One factor was of course the continuous rise in the short term interest rate. The Fed Rate which was at 2.25% at the start of the year 2005 and is now at 4.25% at the end of year. So, to benefit favorably foreign investors invested in the US bonds to enjoy higher yields. But that is in the short term bonds. And this is not that much strong an argument to justify the rise. It made me think other factors which could have played besides the rising short term rate. I did think 2 another equally strong if not more arguments to justify why the USD rise against the global heavyweights. They are:
As written in the article dated 28th Dec. 2005, “Flattening yield curve in the US…why?”, I argued for the lower long term bond yield because of foreigners buying heavily into the US bonds. Because of this there was a huge demand of USD against Euro and Yen, and this can be another factor for the rise.
Another one equally strong argument is the GCC (Gulf Cooperative Council) factor. The GCC include 6 oil exporting countries Saudi Arabia, the UAE, Kuwait, Oman, Qatar and Bahrain. These countries have pegged their currencies against the USD for long. With the rising oil demand and thus the prices, these countries have made their fortunes and have earned around $250 bn during 2005 as oil revenue. Now since these countries’ currencies are pegged against the USD and given the fact that these countries maintain their reserves (which are swelling) primarily in USD, the demand for USD increased for the payment for Oil especially during 2005. So gave another boost to the USD rate.
Hence despite having a record trade deficit (which is set to touch $750 bn for 2005), having been devastated by the most dangerous hurricanes, and the Wall Street legendary Warren Buffet’s not so sanguine view on USD and in fact he is believed to be sitting short on the USD to the tune of $16bn!!! down from $21bn during early 2005…the USD has increased during 2005.
So, the USA should not feel complacent enough…
posted by Vikas Maheshwari, CFA at 9:41 PM
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