Dollar Bulls Hope Fed Aces Policy Transition

Article excerpt

Signs that the US economy is bottoming out and hopes that the Federal Reserve will deftly handle the transition to a less accommodative monetary policy are boosting the dollar, analysts say. They say market participants are confident that the Fed can time the shift hi policy soon enough to head off inflation but late enough to keep the recovery going.

"A key worry in the market right now is higher long-term interest rates," says Marc Lim, foreign exchange dealer at Custom House, a Victoria, British Columbia, Canada, based provider of global payment services. "This is not due to inflation [worries], but because of risk premiums and irresponsible fiscal policy," he says. The sharp jump in US mortgage-lending rates won't help to stabilize che US housing market, but it has pushed the dollar up against all other major currencies, he notes.

The better-than- expected non-farm payroll numbers for May, which showed the smallest decline since September 2008, prompted the federal funds futures market to begin pricing in the possibility of a Fed tightening before the end of 2009.

"This one report has allowed the futures markets to begin pricing in a 30% chance of a movement toward tighter Fed policies as soon as the mid-August meeting and has given it an even greater probability of the Fed moving to tighten rates at its late September meeting," says Dennis Cartmail, Suffolk, Virginia-based publisher of Tfte Gartman Letter advisory service. "This is not going to happen," he says. "The likelihood of the Fed moving to tighten rates until it is very, very clear that the economy is out of recession and that unemployment is at least no longer rising is small, if not infinitesinially so."

However,Atlanta Fed president Dennis Lockhart and Kansas City Fed president Thomas Hoenig warned against waiting too long to raise rates."! suspect we are experiencing the first signs of the markets' concerns [about inflation] in the rising rates and increased volatility in longer-term treasury markets," Hoenig said in early June. "We need to be alert to the markets' message and begin in earnest to bring monetary policy into better balance before inflation forces our hand."

The market is probably getting ahead of itself in terms of anticipated tightening and reducing the fiscal stimulus, says Marc Chandler, global head of currency strategy at New York-based Brown Brothers Harriman. "The only thing that has happened with regards to US economic data is that the pace of decline has slowed," he says. "We question whether the recovery could withstand premature hiking [of interest rates] this year."

Nonetheless, the United States is thought to be the strongest of the major industrialized countries. Chandler says. "Our big-picture view has been that the aggressiveness of the US policy response, coupled with the unprecedented pace that businesses have slashed inventories and fired workers, boosts the chances that the US recovers first," he says.

The surge in the US unemployment rate to a 26-year high of 9.4% in May suggests that some caution is warranted, says Michael Woolfolk, senior currency strategist at The Bank of New York Mellon. "Unemployment is headed above 10% this year, whether the White House acknowledges it or not," he says. "We expect the unemployment rate to break above 10% later this year, prompting work on a second stimulus plan this fall targeted on job creation. …