Signs of Growth in US Economy Boost Dollar's Safe-Haven Role

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CORPORATE FINANCE FOCUS

A batch of better-than-expected US economic data, including nonfarm payrolls and housing prices, gave the dollar a lift last month. Analysts said die signs of strength diminished the need for the Federal Reserve to take additional quantitative-easing steps and strengthened the greenback's appeal as a safe haven. Increased spending by consumers and the US government helped to keep the economy afloat amid a global economic slowdown.

Meanwhile, the euro area's jobless rate rose to a record high of 1 1 .6% in September, as weakness in die peripheral nations spread to the core of the 17-nation bloc and German factory orders fell sharply. Worries about Spain's reluctance to request a bailout program and Greece's wrangling with austerity measures made it appear as if the eurozone's debt crisis was morphing into a chronic illness.

"We retain a favorable oudook for the dollar on a mediumterm basis," says Marc Chandler, global head of currency strategy at Brown Brothers Harriman. "Our big-picture view is that the dollar is carving out an important bottom, after selling off in the third quarter as policymakers moved to reduce the extreme tail risks."

FISCAL CUFF LOOMS

Still, uncertainty about how die so-called "fiscal cliff" - the expiring tax cuts and the new spending cuts set to hit in 2013 - will be dealt with is clouding the dollar's oudook. "If we go over the fiscal cliff, the US [economy] is back in contracting mode, and the Fed may feel better keeping its powder dry until it knows just how large the looming cliff turns out to be," Chandler says.

October readings for purchasing managers indexes (PMI) in die eurozone remained weak, underscoring the difficulties facing nations that are trying to tighten fiscal policy in a recessionary environment, he adds. "Good US data are pushing the euro lower, not die dollar," Chandler says. The dollar is rising on the relatively better oudook for the US economy.

The US jobs report for October was stronger than expected but does not necessarily change die dynamic regarding Fed monetary policy, according to Chandler. He notes that job growth continues at a subpar rate but that the economy is not weak enough to result in a panic move from the Fed.

JAPAN NEEDS WEAK YEN

The dollar rose to a six-month high against the Japanese yen in early November, with Japan's dependence on exports reinforcing the need for a still weaker yen. The Bank of Japan (BOJ) expanded its asset-purchase program and created a new lending facility to provide unlimited fluids to financial institutions at 0.1%. "It is unclear if die new facility will prove useful, since the problem in Japan is one of [lack of] demand for lending, not availability of funds," Chandler says.

Market participants were disappointed with the BOJ's announcement diat it would add 1 1 trillion yen ($137 billion) to its balance sheet, since diey were expecting more.

China's renminbi declined in early November after the People's Bank of China weakened its reference rate ahead of the once-in-a-decade leadership change in the Chinese Communist Party. On November 1, the central bank made a record one-day injection of $28 billion into the banking system through open-market operations.

A wave of deregulation is about to sweep China, according to a report entitled "China's Big Bang," by HSBC economists Qu Hongbin, Sun Junwei and Ma Xiaoping. A series of reforms will revolutionize China's financial system, they predict. "In fact, there are clear signs that China's new leaders, who will take power in early 2013, will make speeding up reform top of their policy agenda in the coming years."

BIG CHANGES IN CHINA

"We think interest rates will be liberalized, the bond market will double in size, and the renminbi will become convertible within five years," HSBC analysts add. "These changes would not only make capital allocation more efficient, boosting the private sector, but also provide the middle class with greater choice about where to put their money so they can earn a higher return and therefore spend more. …