Dollar May Extend Drop Versus Euro on Signs of Weakened Economy

By Ye Xie and Bo Nielsen


June 17 (Bloomberg) -- The dollar may extend its drop against the euro on speculation a weakened U.S. economy will discourage the Federal Reserve from increasing borrowing costs this year.

The U.S. currency fell yesterday as New York state manufacturing shrank in June and crude oil prices touched a record high of $139.89 a barrel. Reports today are forecast by economists to show U.S. housing starts declined last month to a level close to the lowest since 1991 and producer price inflation excluding energy and food items eased.

``I'm not a dollar bull just yet,'' said Marios Maratheftis, a currency analyst at Standard Chartered Plc in London, in an interview on Bloomberg Television. ``There is another wave of dollar weakness to come in the next few months.''

The dollar traded at $1.5475 per euro at 6:02 a.m. in Tokyo, after declining 0.6 percent yesterday, the biggest drop since June 6. The U.S. currency was little changed at 108.23 yen. The yen traded at 167.48 versus the euro, following a 0.7 percent decline yesterday, when it touched 167.68, the weakest level since Oct. 15.

The greenback dropped 0.9 percent to 5.1807 against the Norwegian krone and 0.6 percent to C$1.0236 versus the Canadian dollar yesterday as crude oil touched the record before falling to $133.65 a barrel. Commodities such as oil and gold make up half of Canada's exports, while Norway is the world's fifth- largest oil producer.

The correlation of the dollar against the euro and oil prices is minus 0.93 for the past year, according to Bloomberg calculations based on value changes, indicating they have moved in the opposite direction 93 percent of the time.

`Under pressure'

``As long as oil keeps rallying, the dollar will be under pressure,'' said Richard Franulovich, a senior currency strategist at Westpac Banking Corp. in New York.

The U.S. Dollar Index traded on ICE futures decreased yesterday for the first time in three days, falling 0.7 percent to 73.61. The index, which tracks the dollar against the currencies of six U.S. trading partners, touched 74.31 on June 13, the highest since Feb. 28.

The Federal Reserve Bank of New York's general economic index, a gauge of manufacturing, decreased to minus 8.7 in June from minus 3.2 the prior month. Readings less than zero signal contraction.

U.S. housing starts probably dropped to an annual rate of 980,000 in May, from 1.032 million the previous month, according to the median forecast of 71 economists surveyed by Bloomberg News. The Commerce Department reported that housing starts fell to a 17-year low of 954,000 in March.

Wholesale Prices

The Labor Department will probably report that prices paid to U.S. producers, excluding food and fuel, rose 0.2 percent last month, following a 0.4 percent increase in April, according to the median forecast in a separate Bloomberg survey. Both reports are scheduled to be released at 8:30 a.m. in Washington.

``The Fed would like to hike, but if we continue to get the numbers along these lines, it will be very difficult for them to do so,'' said Matthew Kassel, director of proprietary trading at ING Financial Markets LLC in New York. ``The dollar rally is going to take a rest here.''

Fed funds futures on the Chicago Board of Trade show a 68 percent chance the U.S. central bank will increase the 2 percent target lending rate by at least a quarter-percentage point at its August meeting. There are 26 percent odds policy makers will lift the rate to 3 percent by December.

Bernanke on Economy

The U.S. currency rose last week the most against the euro since 2005 as Fed Chairman Ben S. Bernanke said economic risks have faded. The yield on the two-year Treasury note posted its biggest weekly increase in 26 years last week, rising 66 basis points to above 3 percent.

``The perception that the Fed will hike rates is still strong,'' said Shaun Osborne, chief currency strategist at TD Securities Inc. in Toronto. ``Short-term rates have risen quite sharply the last couple of weeks. That will keep the dollar sustained.''

The dollar will strengthen 3 percent to $1.50 per euro by year-end, according to the mean forecast of 39 firms surveyed by Bloomberg News.

The yen fell to an eight-month low versus the euro yesterday as reduced currency volatility encouraged investors to buy higher-yielding assets funded by low-cost loans in Japan.

Japan's currency dropped 0.8 percent to 17.92 against the Swedish krona and 0.7 percent to 212.23 versus the pound as investors increased carry trades in which they get funds in a country with low borrowing costs and buy assets where returns are higher. Japan's target lending rate of 0.5 percent compares with 2 percent in the U.S., 4 percent in the euro zone, 5 percent in the U.K. and 4.25 percent in Sweden.

The risk that fluctuating exchange rates will erase carry- trade profits fell yesterday. Implied volatility on one-month euro-yen options dropped for a fourth day, declining to 10.07 percent, from 10.31 percent on June 13.