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If U.S. Defaults, Direction of Dollar is Everybody’s Guess

  • By Andrew Deichler and Ira Apfel
  • Published: 2011-07-29

What would happen to the U.S. dollar in the event the federal government defaults after missing the August 2 deadline to raise the debt ceiling?

That is the multi-trillion-dollar question for currency experts and corporate treasury and finance professionals.

USD will rise short-term, fall long-term 

“The only thing we have to compare it to is the subprime crisis in 2008,” said Gareth Sylvester, president of Klarity FX. “And obviously, we saw the U.S. dollar strengthen as people still felt that U.S. treasuries and bonds were the most liquid asset class and therefore, the safest. And that really hasn’t changed. So I would prefer to say that, if we do see a big fallout from the unlikely outcome of not reaching an agreement and defaulting, then I think that will probably lend itself to U.S. dollar strength.”

John Galanek, CTP, chief operating officer of FX Transparency and a member of the Risk Editorial Advisory Board, agrees. “In the short term, U.S. rates would spike,” he said. “This, coupled with the fact that the market is very short USD right now, will likely cause a brief period of USD strength, especially versus EUR and GBP, where similar structural debt problems exist.”

Galanek thinks the USD inevitably will fall over the next 12 months, however, “Longer term, the USD could sell off 15 to 20 percent versus Commodity (AUD, NZD, CAD) and Asian currencies over the coming year as the long-term structural concerns on the fiscal side outweigh the higher U.S. interest rate environment,” he said.

USD will fall short-term, rise long-term 

Wolfgang Koester, CEO of Fireapps, believes the USD will not falter in the short term because the drop already has been priced in. “Otherwise,” he said, “the euro would be at 1.35 today.”

Koester cautions corporates to focus on the USD as it relates to other nations—not as an isolated currency. “This is a political problem in the United States but in Europe, in Greece and Italy and Spain, they are structurally not sound,” he said. “This problem in the U.S. is relatively simple compared to what Europe has to resolve.

“I think the USD will be stronger by year-end than it is today,” Koester added. “I think we need to see what happens with Spain and Italy but you’ll see some significant shifts on other currencies versus the USD. The Swiss franc and gold will strengthen. I see the USD very volatile within a range of 2 to 3 percent and monthly volatility up to 12 to 13 percent.”

Corporate practitioners weigh in 

Three corporate practitioners on the Risk EAB differed about the direction of the USD.

“I think the immediate effect could be dollar strength,” said Sunita Parasuraman, a corporate treasury professional with Facebook. “The dollar remains the world’s reserve currency and most nations with foreign exchange surpluses hold the majority of their reserves in dollars. They wouldn’t dump the USD overnight. Moreover, a U.S. default is bound to trigger worries of a world-wide economic depression since the U.S. is the world’s largest economy. Under that scenario, there will be a flight to the USD as a relatively safer option.”

She added, “Longer term, the USD could lose its status as the world’s reserve currency and would plummet in value.”

Easton Dickson, CTP, Senior Manager, Treasury with Rogers Corp., took the opposite view. “I observed over the past week that rumors of a deal boosted the dollar, while setbacks resulted in euro appreciation,” he noted. “I am of the opinion that a default would result in a quick depreciation as the USD is traded in. However, I do not think the contagion would last, and expect a quick leveling off versus any steep declines.”

Kevin Boyle, CFO of RecoverCare, believes any default will be short-lived. “The market will react as a non-issue,” he said. “The USD is simply too widely held and the disruption would be too great even for our politicians to not reach resolution soon after any self-imposed default deadlines.”

Latest AFP research: Concern is rising 

During a webinar with AFP members Thursday, about 60 percent of the respondents said they were holding more cash to hedge against a potential government default, said Tom Hunt, CTP, AFP’s Director of Treasury Services.

“There is more urgency to hold more liquidity than there was an even a week ago,” he said. “The other 40 percent were either selling treasury money market funds, diversifying asset classes, or simply holding out and waiting for a resolution by August 2.”

More AFP research on raising the ceiling can be found here.

Copyright © 2014 Association for Financial Professionals, Inc.
All rights reserved.

Copyright © 2014 Association for Financial Professionals, Inc. - All rights reserved.
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