The U.S. dollar continues to take its lumps in global foreign exchange markets, a development that has not gone unnoticed by bond investors.
Until now, most fixed-income analysts have blamed foreign investors' lack of confidence in the Clinton Administration for the dollar's descent.
Clinton's credibility problem is not a new phenomenon, nor is it the chief concern weighing on the U.S. currency. But perceptions that the Clinton
Administration lacks a viable foreign policy, reports of the president's disappointment about the recent Federal Reserve rate hikes, and the administration's apparent flip-flopping on dollar-yen policy, have created a less than conducive environment for investors looking to purchases U.S. investments.
Though other issues of concern, such as the U.S. budget deficit, economic growth and inflation, and the future path of U.S. and German
interest rates, have all played roles in determining the value of the dollar, lack of faith in Clinton has been one of the most cited culprits.
"The drop in the dollar in world financial markets shows investors feel the policies of the U.S. are not good for the value of assets near-term," said Brian Wesbury, chief economist at Griffin, Kubik, Stephens & Thompson Inc.
But new evidence suggests that dollar fundamentals and technicals are beginning to add momentum to the greenback's relentless slide.
Today Conference Board Chief Economist Gail Fosler discloses the results of a trend line analysis that projects a 10% decline in the dollar over the next 18 months. Published in the latest issue of Standard & Poor's CreditWeek, Fosler's report predicts the greenback could fall below 1.50 German marks by the end of 1995.
"Deutsche mark/dollar models yield roughly a 10% decline in the dollar over the next 18 months," Fosler said in the report. "This would put the dollar under 1.50 by the end of 1995. Moreover, the time-trend analysis suggests that the dollar has to offer a real interest-rate premium relative to Germany just to keep the dollar stable."
For example, Fosler said, in order for the dollar to appreciate to the 1.80 level, real U.S. long-term rates would have to be two percentage points higher than German rates. That means that against the backdrop of current German inflation and interest rate levels, the U.S. Treasury's 10-year issue yield would have to exceed 8%, almost a full percentage point higher that it is now, she said.
The problem for the bond market in such a scenario is one of sponsorship and the all too apparent lack of foreign demand for U.S. government and corporate securities. Without the help of funds flowing out of other markets into U.S. investments, fixedincome observers continue to argue that the bond market will have a difficult time recovering recent losses.
Treasury market prices weakened Friday as the dollar plunged two pfennigs in less than half an hour Friday in response to the Conference Board report. As the dollar sank against the German mark, government bond prices fell with it, traders said.
The dollar closed Friday at 1.6095 German marks after opening the New York session at 1.6380. Versus the Japanese currency, the greenback ended at 103.65 yen compared with 103.55 at the open.
Fosler went on to say an apparent truce in U.S.-Japanese trade relations and recent stability in domestic financial markets give rise to a new round of dollar optimism. Yet the dollar sinks versus the Japanese yen and stagnates against the German mark, suggesting that the greenback's strength is more myth than reality.
"Is the dollar's weakness vis-a-vis both currencies a temporary reversal in a trend toward unremitting appreciation? Or does the absence of sustainable dollar support suggest something more fundamental is at work?" Fosler asks in the report.
Part of the answer, she said, is found in looking at the trend of German mark and yen values versus the dollar. The time-trend and purchasing power parity indexes both point to a tendency for the dollar to weaken against these key currencies. Indeed, inflation is generally lower in Japan and Germany than in the U.S., she said.
Interesting about the current foreign exchange environment is that the yen is not particularly highly valued versus the dollar, Fosler said. While 110 to 112 yen might be considered the central value currently, or the value that the yen would return to in the absence of political stress and uncertainty, the yen would not be considered high, that is, approaching one standard deviation from the time-trend, until it reached 90-100 versus the dollar.
The German mark versus dollar relationship is a bit more complex, she said. The deviations of the actual German mark/dollar rate from the time-trend can be explained by relative real interest rates both long and short term. Higher real rates in the United States tend to strengthen the dollar; higher real rates in Germany tend to support the mark.
Here again, Fosler said, the news for the dollar is not particularly good. The fall in German interest rates in advance of the decline in German inflation cut real interest rates in Germany in 1993 and early 1994, especially on the long end.
The reverse appears to be the case with German long-term rates rising in sympathy with U.S. rates and German inflation headed down. Only if U.S. inflation were to decline from its current 3% level, or German inflation were to surge, would U.S. real rates rise relative to German rates, Fosler said.
To reverse these trends, Fosler said, the U.S. would have to adopt a high real interest rate policy that would set as a clear priority reducing inflation at the expense of growth. Neither the Fed nor the political climate now support such a shift.
Treasury Market Friday
A sharp decline in the U.S. dollar, signs of strength in the University of Michigan consumer confidence survey, and higher commodities prices sent Treasuries sharply lower Friday.
The 30-year bond closed down almost a point, to yield 7.44%.
Treasury Market Yields !!!BEGIN TABLE Prev. Prev. Friday Week Month3-Month Bill 4.20 4.20 4.236-Month Bill 4.62 4.67 4.701-Year Bill 5.14 5.16 5.082-Year Note 5.83 5.82 5.753-Year Note 6.18 6.14 6.115-Year Note 6.68 6.59 6.577-Year Note 6.74 6.63 6.6310-Year Note 7.11 7.00 7.0030-Year Bond 7.44 7.30 7.30!!!END TABLE
Source: Cantor, Fitzgerald/Telerate
Treasuries fell in reaction to a falling dollar on bearish statements made by the Conference Board economist.
In thin summer trading with many players absent because of sporting events, a railroad strike, and a victory parade for the New York Rangers, Fosler's comments had a significant impact on bond, foreign exchange, and stock markets.
The Michigan index rose 94.5 in mid-June from 92.8 in May, while the current conditions index was at 107.3 versus 106.3 and the expectations index was up to 86.2 compared with 84.2 in May.
Commodities prices also moved to center stage Friday as the Commodity Research Bureau's index of 21 futures prices rose more than two points to 239.35.
The short end of the market came under pressure early in the New York session as dealers began setting up for the upcoming monthly note auctions. The Treasury is scheduled to sell $24 billion of bills and another $28 billion of notes next week.
In futures, the September bond contract ended down 28/32 at 103.30.
In the cash markets, the 5 7/8% two-year note was quoted late Friday down 5/32 at 100.01-100.02 to yield 5.83%. The 6 3/4% five-year note ended down 11/32 at 100.06-100.08 to yeld 6.69%. The 7 1/4% 10-year note was down 22/32 at 100.25-100.29 to yield 7.11%, and the 6 1/4% 30-year bond was down 31/32 at 85.23-85.27 to yield 7.44%.
The three-month Treasury bill was
unchanged at 4.20%. The six-month bill was up three basis points at 4.62%, and the year bill was up four basis points at 5.14%.
