Is it time to ride the dollar bull?

Euro in trouble against the dollar

On the foreign exchange front, the year 2011 would be remembered most by the rising tide of the Eurozone debt crisis. At the end of 2010, the ratio of sovereign debt to gross domestic product for the 17 Eurozone countries was 85.5 percent. The worst impacted country was Greece, with a debt-to-GDP ratio of 143 percent.

The European debt crisis is entering its third year with no end in sight. In 2010, Greece was the only country affected by the debt crisis, but now Italy, Spain and Ireland are also in the firing line. Credit rating agencies have started European downgrades. The biggest affected are Italy, Spain and Portugal – all downgraded two points to BBB+, three steps above junk status.

France, Austria, and Belgium also lost a rating points to AA+. However, the maintaining of AAA ratings for Germany, Netherlands, Finland and Luxemburg is cheerful news for the Euro.

Last December, the European Central Bank made an unprecedented cash injection to supply €489 billion of three-year loans that helped ease short-term borrowing costs for Italy, Belgium and Spain. This was welcome news in the wake of any real solution to the euro debt crisis and is likely to ease the recession risk for now. However, long-term investor concerns about the Eurozone are likely to remain intact in the first half 2012 as the debt crisis continues to pose risks to Eurozone growth.

Weak European growth, the EU debt crisis and favorable economic signals from the U.S. are likely to weigh on the Euro. Even though the European debt crisis has stabilized for now, the market is still concerned about long-term euro risks, and risk-appetite trading is likely to drive the euro lower in the first quarter of 2012. The euro risk is causing investment money to flow into U.S. equity markets, thereby increasing demand for the U.S. dollar.

The only real hope for the Eurozone lies in sustained growth from emerging economies, and until GDP growth signs emerge from Europe, investors are likely to be happy parking their money in dollar-based assets and gold.

Optimism for U.S. dollar

Improved U.S. economic data is also supportive of this early dollar optimism for 2012. The U.S. unemployment rate showed an improving trend in the second half of 2011, where it reduced from a high of 9.1 percent in January and mid-2011 to a low of 8.5 in December 2012. A lowering unemployment rate is good news for the dollar. On the other hand, a drastic reduction in the unemployment rate below 8 percent is not expected in 2012 because of structural problems in the U.S. job market, where the skills in demand by companies are disconnected with the labor market. Overall, there will be sluggish job growth in the U.S. in 2012 that could lead to marginal improvements in personal income and consumer spending. 

As 2011 came to a close, U.S. economic data appeared to have lined up in the dollar’s favor. The real GDP increased at an annual rate of 1.8 percent in the third quarter of 2011. That compares favorably with the second quarter, in which real GDP had increased by 1.3 percent. The next release of the GDP data is due January 27, 2012.

The slow improvement in U.S. GDP is likely to continue into 2012. In the first half, the modest growth in GDP is expected to rise to about 2.5 percent before stabilizing to a 2 percent growth rate in the second half of 2012. The main driver behind the modest growth in GDP is going to be consumer spending. On the other hand, consumer spending is expected to remain in check by the slow pace of job growth and relatively modest gains in personal income.

The U.S. deficit also showed an improvement in October 2011 to -$43.5 billion from -$44.2 billion in September 2011. U.S. exports are likely to be supported by exports increase to emerging market economies, while on the other hand, exports to Europe could be capped in the light of the modest recession in Europe. All this economic data and the euro risk are supportive of the U.S. dollar in the first half of 2012.

Is euro-dollar headed to 1.20?

In 2011, the euro traded at a high of 1.4941 and a low of 1.2861 against the dollar. Technically, the euro is vulnerable to an accelerated fall to 1.20 in the first quarter of 2012. In the second half of 2012, I expect the 1.20 support to give way to test a next support at 1.10. The euro is forecast to remain a sell against the dollar in the first quarter with resistance at 1.29 likely to remain tough to breach.

530 dollar-colón rate possible by end of first quarter

The global strength of the U.S. dollar in early 2012 is expected to have a bearish influence on Costa Rica colones. The dollar traded in a narrow range against the colón in 2011, between a low of 494.50 and a high of 517.20. It ended the year at 504.70. The Dollar-colón is completing a bottoming action on the charts and is expected to break resistance at 514.50 to signal a move towards 530, likely by the end of first quarter of 2012.

The exchange rate range in the first half of 2012 is likely to remain between 502 and 530. The dollar is forecast to be a buy on the dips mode against colones, since strong support exists on the technical charts at 503.75 and 502.60. The 530 objective is also the first major retracement target of the decline from the September 2009 high of 589.70 to May 2011 low of 495. Conventional economic wisdom suggests the weaker-expected colones could lead to increased exports to the U.S., while making U.S. imports more expensive for Costa Rican importers. This could lead to a widening of the nearly $4 billion trade surplus Costa Rica enjoyed with U.S. in 2012. It could also bring in more tourism and investment dollars into the Costa Rica economy in 2012. On the flip side, it could lead to inflationary pressures in 2012, which could dampen the Central Banks’s target of containing 2012 inflation rate to 4 percent.

Mozammil Awan is an expert in the art of technical analysis of forex, commodities, and stock markets. He also has vast experience in aerospace-satellite design, wireless communications and medical-product design and manufacturing. He currently works in Costa Rica’s largest medical device manufacturing company, Hospira, where he heads the infusion pump engineering department. The views and opinions expressed in this article are those of the author. The Tico Times and the author are not responsible for any actions and decisions taken by readers based on this article.