Brown Brothers thinks that the dollar will strengthen in the near term, even as the economy continues to flounder. As bad as things are in the U.S., the firm says, they’re even worse in other G7 economies:
One of the key factors that have contributed to the dollar’s weakness has been the under-performance of the US economy and the rates cuts seen in response. We think that the news stream is improving in this regard. In fact, it is possible that the US economy was the best performer in the G7 in Q2, and could be doing it again here in Q3.
What’s more, U.S. growth is expected to pick up in Q2 and exceed earlier estimates, just as Japan and Europe begin to sink further:
We had projected a 1.5% pace in Q2, but this seems too conservative. Indeed the US economy appears to have grown at around twice the pace of Q1. recognising that H1 08 growth has been significantly better than expected, both the IMF and the Federal Reserve have now revised higher their forecasts made in the spring. This stands in stark contrast with what is happening in the other major industrialized countries.
In Britain, growth is collapsing. In Britain’s most recent estimate for GDP, officials reported that the economy expanded at less than a 1% annualized rate in Q2 and said growth would fall even more in the third quarter. In Germany and Japan, things are even worse:
Yet the world’s second and third largest economies, Japan and Germany, do not appear to have fared even this well. It seems likely that both economies contracted in Q2, or at least stagnated. Japan’s economy stands on three legs: government spending, exports, and capital spending. Each leg has been cut from under it… Germany’s Economics Ministry has acknowledged that its economy may have contracted in Q2.
Brown Brothers thinks that this can only mean one thing: a stronger dollar over the long term, though it may be a bumpy road on the way:
We look for the dollar’s base to broaden and deepen, but recognise that the market needs to become more convinced of the trajectory of monetary policy and needs to see greater evidence that the economic momentum in the US in Q2 carried into Q3… We continue to advise medium- and long-term investors to take advantage of dollar declines to buy the greenback and/or reduce European currency exposure directly or through increasing hedges. Just like when the dollar was topping at the start of this decade, so too now, the process of carving out a cyclical extreme will take a prolonged period of time, and the rolling financial crisis makes underscores the protracted nature of this process.