The US Dollar Gains-VRK100-05Oct2011

The US Dollar Gains - Why?

Credit rating agency, Standard & Poor’s, downgraded US credit rating in the first week of August 2011. Following the downgrade, it was expected that the dollar would weaken against other currencies. Against this background, it is difficult to provide a logical explanation to dollar’s relative strength after the S&P downgrade.

However, let me try to make some sense out of this counter-intuitive behaviour of investors. The US dollar is still regarded as a global reserve currency and its usage is very widespread across the globe for trade and other purposes. Immediately after the S&P downgrade of the US, global investors started moving their money to gold, other commodities, Swiss franc and Japanese yen.

During the first week of September 2011, Swiss National Bank (SNB) announced it had pegged its currency Swiss franc (CHF) to euro (EUR) shocking the currency markets. Concerned that the massive overvaluation its franc would hurt Swiss exporters and may jeopardize their economy, the SNB said that it would not tolerate a EUR-CHF exchange rate below the minimum rate of CHF 1.20.

At around this time, sovereign debt crisis in the eurozone has deepened. Global financial markets have started worrying about the prospect of Greece defaulting on its sovereign debt and a possible break-up of eurozone.

So, investors have no choice but to rush to the safety of US dollars. They started moving away from euro and Swiss franc to dollar. Even Japanese government too intervened to stop the yen appreciating against the dollar. Japan is highly dependent on exports and yen appreciation affects them adversely.

During the first half of this calendar year, the US dollar had weakened against major currencies. The US dollar index (the indexed value of the US dollar against six major currencies, like, euro, pound sterling, Japanese yen and so on) went down to a level of 72.5 in July 2011. But, after two months, the dollar gained substantially and the US dollar index is now hovering around 79.5 showing the dollar has appreciated by nearly 10 per cent in the last two months.

Currencies in the emerging markets too have lost by about five to 15 per cent against the US dollar in the last one month. The Indian rupee has lost around 10 per cent against the dollar in the last two months.