Dollar Might Be Losing Out

Recent developments in the forex market do not bode well for the US dollar.  Short-term economic data is bearish.  The long-term outlook for the US economy is getting worse every day.  And the currency crosses are not just about dollar weakness as there is strong support for the other highly traded currencies (even the yen).  To exacerbate matters for dollar bulls, there is a movement to unravel the dollar’s preeminent position as the financial medium of choice internationally.

A good place to start is the economic data released today: US Retail Sales.  The Commerce Department reported a drop of 0.9% blowing past initial estimates of a drop of only 0.1%.  It is the largest one month drop since August 2005.  With oil prices above $70 per barrel and home values tumbling, consumers are being stretched further than many economists had anticipated.

The recent numbers put the US economy in a precarious position.  Higher job and wage growth should be conducive for a steady pace of expansion.  But the retail sales number is particularly significant.  Retail Sales accounts for one half of all consumer spending which itself accounts for two-thirds of the economy.  A slowdown in this sector could be a harbinger for a larger contraction.  Concern over this matter, coupled with the continuing problems over subprime loans sets the stage for greater bond demand and lower interest rates.

As if that wasn’t enough bad news for the US dollar, Iran has made some very troublesome moves.  Bloomberg News has reported the National Iranian Oil Co. just asked Japanese oil refiners to pay for their oil imports ($10.1 billion worth) with yen instead of dollars.  With rising tensions with the United States, the Iranians are trying to hedge their risk by limiting their dollar exposure.  To this end, Iran is also seeking to diversify their foreign exchange holdings, limiting US dollar reserves to 20% of the total while buying more euros and yen.  Central bankers in Venezuela, Indonesia and the United Arab Emirates are pursuing much the same course with regard to their foreign exchange reserves.  USD/JPY is now down 0.22% to 122.13.  Much of the reason the US dollar has been able to maintain much of its strength all these years despite long-term double deficits is because of its preeminent position as the currency of exchange throughout the world.  If that position is being eroded (and it looks like it might be), then the decline of the dollar might be just beginning.