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Capital Markets

Bond Outlook November 16th

The strong dollar results directly from relative interest rates. The current cycle will move upward till the housing bubble deflates and then reverse. Next Spring? After four more Fed hikes?


Bond Outlook
[by bridport & cie, November 16th 2005]

How can a country whose external current account deficit keeps growing have a strong currency? It is only a couple of years since USD 45bln per month seemed unsustainable, and the dollar had to weaken. The dollar did indeed fall, but since then the deficit has widened to a regular USD 60 bln per month. Does this imply that the USA cannot balance its current account just by a weaker dollar? Probably, yes. Does it mean that the dollar is bound to weaken over time? Probably yes, but with the overlay of a very distinctive cycle.

 

The cycle can be described very simply: when interest rates in the USA go up relative to the JPY and the EUR, the USD strengthens, and vice versa. The Fed is committed to tightening. Our guess some weeks back of a 4.5% target now looks understated. Commentators are expecting more like 5%, with two more rises under Greenspan, and then two under Bernanke. Inflation control is the ostensible reason for this policy; behind it, however, lies the need to deflate the housing bubble gently.

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