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January 10, 2011

Three Top Forecasters Favor Dollar as Wells Fargo Sees 5% Gain Versus Euro
By Allison Bennett – Jan 10, 2011

The world’s most accurate foreign- exchange forecasters say the dollar will be the best currency to own this year as the Federal Reserve’s bond purchases bolster the U.S. economy instead of debasing America’s legal tender.

Wells Fargo & Co., Bank of Tokyo-Mitsubishi UFJ Ltd. and SJS Markets Ltd., the top analysts in the six quarters ended Dec. 31, according to data compiled by Bloomberg News, say the dollar will strengthen against the euro, yen and pound. Nick Bennenbroek, the head strategist at Wells Fargo in New York and the most accurate of the group, predicts about a 5 percent gain against the euro over the year and 11 percent versus the yen.

The survey underscores the sudden turnaround in the U.S. economy two months after the greenback fell to its weakest level in almost a year in November. Traders have turned their focus away from the Fed’s plan to print cash to buy $600 billion of Treasuries and toward Europe’s debt crisis, deflation in Japan and U.K. austerity programs.

“The superior growth performance of the U.S. should shine through in 2011,” said Bennenbroek, 40, who joined the bank in 2007 and began his career in the forecasting department at the New Zealand Treasury in Wellington. “We will see the economic recovery in the U.S. outpacing that of Europe, Japan and even the U.K., which would see the dollar stronger against those currencies.”

Better Economic Data

The dollar’s outlook improved as data showing gains in jobs, manufacturing and retail sales the past six weeks helped drive IntercontinentalExchange Inc.’s Dollar Index up 7.1 percent to 81.012 on Jan. 7 from last year’s low of 75.631 on Nov. 4. That was a week before the Fed began buying government debt to spur the economy in a policy known as quantitative easing, or QE. The index fell 0.1 percent to 80.908 at 12:57 p.m. in New York today.

“Back in September and October, the world was debating the prospects of more QE in the U.S. — dollar negative — while now investors are debating the chances of the Fed doing less than the $600 billion of QE — dollar positive,” Valentin Marinov, a currency strategist at Citigroup Inc. in London, wrote in a research note on Jan. 6.

The U.S. economy will expand 2.6 percent this year, according to the median of 68 forecasts compiled by Bloomberg. Growth in the euro region will rise 1.5 percent, with Japan at 1.3 percent and the U.K. at 2 percent, surveys show.

Surging Dollar

The dollar jumped 3.70 percent against the euro last week, the most since August, to $1.2907. Japan’s currency fell 2.4 percent, the biggest weekly decline since December 2009, to 83.15 per dollar. The pound slipped 0.4 percent to $1.5548. The greenback will end the year at $1.31 per euro, 90 yen and $1.58 to the pound, based on the median of more than 30 forecasts compiled by Bloomberg.

Bennenbroek said the dollar will benefit from rising interest rates on U.S. bonds. Inflation-adjusted, or real, yields on 10-year Treasuries climbed to 2.18 percent last week from 1.46 percent at the end of October. The dollar surged 8.06 percent versus the euro in the period, 3.42 percent against the yen and 3.15 percent to the pound.

“We’re getting some of the most encouraging signals we’ve seen in a while in terms of data, so bond yields are going up and supporting the dollar,” he said.

Employers added 103,000 workers in December, a third month of gains, the Labor Department in Washington said on Jan. 7. Manufacturing in the U.S. expanded last month at the fastest pace in seven months, while retailers’ 2010 holiday sales jumped 5.5 percent for the best performance since 2005, reports in the past two weeks showed.

Currency Controls

The dollar may benefit should increasing U.S. consumption appease nations from Brazil to China that are struggling to keep their exchange rates from appreciating. Brazil’s central bank introduced controls on some dollar positions held by local banks on Jan. 6, its third attempt since October to stem strength in the real, which rose 14 percent from its closing low last year on Jan. 29 through year-end.

“The first half of the year across the board is going to be a supportive environment for the dollar,” said Stephen Gallo, head of market analysis at Schneider Foreign Exchange in London, the fifth-best forecaster. “The U.S. is perpetuating its normal style of growth, which is consumer driven, and the emerging-market world is able to perpetuate its export-driven model, which is not a negative scenario for the dollar.”

Europe’s currency may rebound as U.S. growth fades amid trillion-dollar deficits and record low central bank rates, said Jeremy Stretch, executive director of foreign-exchange strategy at Canadian Imperial Bank of Commerce in London, the No. 7 forecaster overall and No. 2 for dollar-yen.

Interest Rates

The Obama administration’s 2011 budget predicts a $1.267 trillion deficit for the fiscal year ending Sept. 30. The Fed won’t raise its target rate for overnight loans between banks until 2012, boosting it to 0.75 percent from a range of zero to 0.25 percent, according to a Bloomberg survey.

America’s currency may rise to $1.22 per euro before weakening in the second half as the European Central Bank “becomes more mindful of the residual strength of the German economy” and raises rates, said Stretch. CIBC sees the euro at $1.32 by Dec. 31.

Bennenbroek’s picks helped Wells Fargo beat 55 firms across eight currency pairs with a 4.97 percent average margin of error, data compiled by Bloomberg show. His calls, assisted by strategist Vassili Serebriakov, 33, ranked first in sterling, second in euro-yen and third in the euro versus the dollar.

Supplanting Standard

Wells Fargo climbed from third place in the second and third quarters of 2010 and sixth in the first quarter to unseat Standard Chartered Plc, based in London. Tokyo-based Bank of Tokyo-Mitsubishi, which had a 5.07 percent margin of error, and Hong Kong-based SJS, an independent global financial-services company with 5.64 percent, came next. SJS, which doesn’t currently have a foreign-exchange analyst, declined to comment.

“We are dollar bulls when it comes to major currencies and we did well as dollar bulls in 2010 because of the euro,” said Moscow-born Serebriakov, who joined Bennenbroek in 2008. “We will have a market that is more focused on U.S. events in 2011 from the logic that the recovery is picking up pace and U.S. news will play more prominently.”

Derek Halpenny, European head of global currency strategy at Bank of Tokyo-Mitsubishi since 2008, had the lowest margin of error for the euro against the dollar at 4.96 percent. He said the dollar would strengthen in November 2009, when the euro traded at $1.51. He is still bullish.

‘Same Story’

“It comes back to the same story: relative fundamentals and the expectations that are built into the market in regards to future monetary policy,” said Halpenny. “Ultimately that is where the dollar bears get carried away, saying the Fed is printing money, debasing their currency and the dollar is going to go down. It just isn’t backed up.”

U.S. 10-year real yields are more than a percentage point higher than the Japanese equivalent, which ended last week at 1.11 percent. Euro real yields were at 0.97 percent and the U.K. at 0.21 percent.

Halpenny, 40, recommends betting the pound will fall against the Canadian dollar, which will benefit from stronger U.S. growth. The U.S. is Canada’s largest trading partner.

“We are bearish on the pound,” he said. “They are now about to embark on quite aggressive fiscal consolidation and that to us points to pound underperformance.”

U.K. Opposition

Britain’s government has faced opposition over planned austerity measures designed to cut a record budget deficit. Student protests against an increase in tuition fees turned violent last month, while union leaders have said they may strike against proposed job cuts.

The foreign-exchange analysts were compared based on the forecasts at the end of each quarter for the close of the next, starting with the third quarter of 2009. One annual estimate which was made at the end of Dec. 2009 for exchange rates as of Dec. 31, 2010, was also included. All estimates were weighted equally.

Only firms with at least four forecasts for a particular currency pair were ranked for it, and only those that qualified in at least five of eight pairs were included in the ranking of best overall predictors. In all, 55 firms submitted enough forecasts to be ranked in at least one currency.

—With assistance from Anchalee Worrachate in London, Chris Fournier in Montreal, Ron Harui in Singapore and Liz Capo McCormick, Phil Kuntz and Mary Lowengard in New York. Editors: Daniel Tilles, Robert Burgess

Wall Street Dumps Most Treasuries Since 2004 as Primary Dealers See Growth
By Daniel Kruger – Jan 10, 2011

Wall Street banks are cutting their holdings of Treasuries at the fastest pace since 2004 as the world’s biggest bond firms bet that the economy will strengthen and demand for higher-yielding assets will increase.

The 18 primary dealers that trade with the Federal Reserve reported that holdings of U.S. government debt tumbled to a net $2.34 billion on Dec. 29 from $81.3 billion on Nov. 24, the most since June 2009, according to the most recent central bank data. While the stake is the lowest since February, corporate bond and mortgage securities have risen from the lows of the year.

Dealers had stocked up on U.S. debt anticipating demand from customers who wanted to sell the securities to the central bank as part of Fed Chairman Ben S. Bernanke’s plan to buy $600 billion of Treasuries. Government bonds lost their allure as stocks rose, corporate financing conditions eased, expectations for inflation increased and the dollar strengthened.

“Slowly but surely the economy’s getting on stronger footing,” said John Fath, who helps manage $2.5 billion as a principal at investment firm BTG Pactual in New York and was the former head government-bond trader at UBS Securities LLC, a primary dealer. “There are people moving or thinking of moving out of risk-free assets. This is what Bernanke wanted.”

Berkshire Hathaway Inc., the Omaha, Nebraska-based holding company controlled by billionaire Warren Buffett, and General Electric Co.’s finance unit led companies selling a record $48.5 billion of bonds in the U.S. last week as relative yields on investment-grade debt shrank to the narrowest since May.

Growth Prospects

Dealers typically pare Treasuries holdings as company debt sales accelerate, according to Mitchell Stapley, the Grand Rapids, Michigan-based chief fixed-income officer for Fifth Third Asset Management, which oversees $22 billion. This represents “the normal functioning of the market,” he said.

Prospects for faster economic growth caused Treasuries to lose 2.67 percent last quarter, including reinvested interest, trimming the annual gain to 5.88 percent for 2010, Bank of America Merrill Lynch’s U.S. Treasury Master index shows. Company bonds lost 0.57 percent in the three months ended Dec. 31, cutting their annual gain to 10.8 percent.

Yields on 10-year Treasuries, which serve as a benchmark on everything from corporate loans to mortgages, rose 3 basis points to 3.32 percent last week. Primary dealers forecast the yield will climb to 3.65 percent by the end of the fourth quarter, a Bloomberg News survey last month showed. Yields dropped as low as 2.33 percent on Oct. 8. Yields were little changed at 3.32 percent at 7:26 a.m. in New York.

‘Tone Has Shifted’

While rising, 10-year yields remain below their average of 5.43 percent since 1990 even though the U.S. is running a budget deficit that exceeds $1 trillion, or more than 8 percent of the economy. The last time the U.S. had a surplus, from 1998 through 2001, yields averaged 5.45 percent.

“You’re not going to see a repeat of the low yields that we’ve seen in the last six months,” said Sean Simko, who oversees $8 billion as a managing director at SEI Investments Co. in Oaks, Pennsylvania. “The overall tone has shifted. The trend is higher in yield, but it won’t be in a straight line.”

Yields on 10-year notes will hold below 4 percent for a fourth consecutive year in 2011, according to the median estimate in a Bloomberg News survey of the primary dealers.

Some of the optimism over the recovery was tempered Jan. 7 when the Labor Department in Washington said U.S. payrolls increased by 103,000 in December, below the median forecast of 150,000 in a Bloomberg News survey.

Rate Hedge

Dealers usually bet against Treasuries to hedge against the risk that changes in interest rates will erode the value of their corporate and mortgage-related debt. In the five years before Lehman Brothers Holdings Inc. collapsed in September 2008, dealers had an average $107 billion net short position, compared with an average $24.2 billion bet in favor of the debt since 2008, Fed data shows.

Wall Street’s holdings of Treasuries swelled to a 17-month high of $81.3 billion on Nov. 24 from $18.4 billion on Aug. 18, just before Bernanke gave a speech in Jackson Hole, Wyoming, that bolstered speculation the Fed would resume purchases of government debt to boost the economy and avoid deflation. The official announcement came Nov. 3.

Firms dumped Treasuries as reports pointed to sustained economic growth, said Amitabh Arora, an interest-rate strategist at primary dealer Citigroup Inc. in New York. “There was a lot of capitulation of bad positions,” he said.

‘Point of Equilibrium’

While last week’s jobs report fell short of forecasts, other data from the government, Fed and private sector since December showing gains in manufacturing and industrial production have prompted economists to increase their estimates for gross domestic product.

New York-based JPMorgan Chase & Co., the second-biggest U.S. bank by assets, boosted its 2011 forecast by half a percentage point to 3.1 percent. A government report on Jan. 14 will show retail sales rose for a sixth month, economists said.

“We still have headwinds, but their strength has been somewhat offset by the increase in tailwinds,” said David Ader, head U.S. government bond strategist at CRT Capital Group LLC in Stamford, Connecticut. “Maybe we’ve reached a point of equilibrium.”

In the corporate debt market, investment-grade bond yields have shrunk to within 163 basis points, or 1.63 percentage points, of Treasuries, Bank of America Merrill Lynch index data show. Spreads were 181 basis points a year ago and 574 in 2009.

“You’re not seeing a lot of pushback” from investors on new bond sales, said Timothy Cox, an executive director of debt capital markets at Mizuho Securities USA in New York.

Corporates, Mortgages

Speculative-grade companies, those rated below Baa3 by Moody’s Investors Service and BBB- by Standard & Poor’s, can sell bonds at yield spreads averaging 523 basis points, down from 603 a year ago and 1,642 two years ago, based on Bank of America Merrill Lynch indexes.

Primary dealer holdings of corporate bonds due in more than one year totaled $85.7 billion on Dec. 29, up from last year’s low of $75.7 billion on Aug. 4. Mortgage securities totaled $58.8 billion, compared with $31.8 billion on March 10.

Gains in equities and the dollar also suggest rising confidence in the economy.

The Standard & Poor’s 500 Index rose 24 percent to 1,271.50 from last year’s low on July 2. IntercontinentalExchange Inc.’s Dollar Index, which tracks the greenback against the currencies of six major U.S. trading partners including the euro, yen and pound, advanced 2.51 percent to 81.012 last week, and has surged 7.1 percent from 2010’s low of 75.631 on Nov. 4.

Breakeven Rates

The outlook for inflation is also rising. The difference between yields on 10-year notes and Treasury Inflation-Protected Securities, a gauge of trader expectations for consumer prices, widened to 2.43 percentage points on Jan. 5, the most since April.

“If the market expects the economy to strengthen, investors ratchet back expectations for Fed purchases and reduce their bid for the assets, and rates rise,” Fed Governor Elizabeth Duke said in the text of a speech in Baltimore on Jan. 7. The recent rise in yields “is due to exactly this latter circumstance — a strengthening in market participants’ outlook for the economy and a corresponding decrease in the market’s expectation for future accommodation,” she said.

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