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Dec. 3 (Bloomberg) -- At a time when everyone from billionaire investors such as Warren Buffett and Bill Gross to celebrities want nothing to do with the dollar, a growing number of strategists say the stage is being set for a rally in 2008.
The U.S. budget and trade deficits are narrowing in tandem for the first time since 1995, when the currency gained 8 percent as measured by the Federal Reserve's U.S. Trade Weighted Dollar Index.
``I am confident that the dollar will have a significant rally next year, especially against the euro and the pound,'' said Stephen Jen, the London-based head of currency research at Morgan Stanley, who expects the U.S. currency to strengthen to $1.35 by December 2008. ``The deficits are shrinking fast.''
The dollar traded at $1.4666 against the euro as of 8:29 a.m. in London, from $1.4633 at the end of last week.
While Berkshire Hathaway Inc. Chairman Buffett and Gross say investing in U.S. financial assets is a losing proposition as the nation's economic and political dominance wanes, improvements in the deficits may provide a respite for the dollar after it tumbled 12 percent this year. Gross manages the world's largest bond fund as chief investment officer of Pacific Investment Management Co. in Newport Beach, California.
Currency Forecasts
The currency may appreciate 7 percent against the euro in 2008 from a record low of $1.4967 reached on Nov. 23, according to the median forecast of 38 strategists by Bloomberg. Frankfurt- based Deutsche Bank AG, the world's largest currency trader, expects the dollar to rise 4.3 percent. Royal Bank of Scotland Group, the U.K.'s second-biggest bank, reversed its outlook last week and predicts the dollar will appreciate.
A depreciating dollar has helped American exports rise to records in each of the past seven months, the longest streak since 2000. The trade deficit narrowed to $56.5 billion in September from the record $67.6 billion in August 2006, data compiled by the Commerce Department show.
Both President George W. Bush and Treasury Secretary Henry Paulson have hailed exports as a bright spot in an economy that's mired in the worst housing slump in 16 years. Paulson, who has said having a strong currency is in the national interest, added on Nov. 16 that the ultimate value of the dollar will reflect ``long-term strength'' in the American economy. A narrowing deficit means fewer dollars are being converted to foreign currencies through trade. The U.S. Treasury sets dollar policy.
No `Heat'
The budget deficit for fiscal 2007 ended Sept. 30 shrank to $162.8 billion, according to Treasury data. It is the smallest shortfall since $158 billion in 2002, and down from $413 billion in 2004, according to the Treasury.
``The twin deficits have been feeding a bearish dollar market over the past few years,'' said Michael Malpede, an analyst in Chicago at MF Global Ltd., the world's largest broker of exchange-traded futures and options. ``If the deficits continue to show improvement, they will definitely take some heat off the dollar.''
The dollar posted its largest weekly gain since August versus the euro, rising 1.4 percent, after Federal Reserve Chairman Ben S. Bernanke signaled he may lower interest rates for a third time since September to bolster growth, reducing concerns about recession. It strengthened 2.7 percent last week versus the yen, its biggest increase since the period ending Dec. 10, 2004.
Dollar Bears
Only New York-based Citigroup Inc. and Merrill Lynch & Co., Amsterdam-based ABN Amro Holding NV, the investment-banking unit of Toronto-based Bank of Nova Scotia, and Johannesburg-based Standard Bank Group Ltd. are predicting a drop next year for the dollar among the 38 securities firms surveyed over the past month. They each see it depreciating to at least $1.47 per euro.
``Even if the current-account deficit would get smaller, it is still very difficult for the U.S. to finance it'' with interest rates falling, said Greg Anderson, an analyst in Chicago at ABN Amro. He said the dollar may drop to $1.53 by the end of 2008. The current account is the broadest measure of trade.
Both Buffett, the world's third richest man as measured by Forbes Magazine, and Gross, who Forbes says is worth $1.2 billion, have said they're bearish because interest-rate cuts by the Fed dim the allure of U.S. assets. In a video for the movie ``American Gangster,'' hip-hop musician Jay-Z flashes a wad of 500-euro notes while driving through New York.
Buffett told reporters in South Korea on October 25 that he bought stocks in companies that earn money in other currencies. Gross said he expected the Fed to cut borrowing costs to around 3.5 percent over the next 12 to 18 months. The central bank's target rate for overnight loans between banks is 4.50 percent.
Fed Rates
The dollar lost 40 percent of its value against the euro during its five-year slide as widening deficits raised concern over the capability of the U.S. to attract foreign money. Former Fed Chairman Alan Greenspan said in November 2004 that overseas investors will eventually tire of funding the current-account gap and may channel money into other currencies.
Plus, Buffett and Gross may turn out to be right if the worst housing market in 16 years pushes the economy into recession, further diminishing the dollar's appeal.
Corporate profits, as measured by the Commerce Department, fell at an annual rate of $19.3 billion in the third quarter from the second, as domestic earnings dropped by $41.2 billion. Peoria, Illinois-based Caterpillar Inc., the world's largest maker of bulldozers and excavators, told investors in October that it expected the economy to be ``near to, or even in recession'' in 2008.
The Fed is the only major central bank in the Group of Seven to cut interest rates this year, dropping its target from 5.25 percent since September. The European Central Bank and the Bank of England held rates unchanged at 4 percent and 5.75 percent respectively.
Bear to Bull
``The Fed has done a lot of work relative to other central banks,'' said Adam Boyton, a senior currency strategist in New York at Deutsche Bank, who expects the dollar will strengthen to $1.40 per euro. ``Two-thousand-eight is going to stop the one-way story we have seen.''
The median forecast of strategists is for a 5 percent gain to $1.40 against the euro in 2008. Redtower Ltd. in Aberdeen, Scotland, is the most bullish, calling for the dollar to gain to $1.23 by the end of next year.
Jim O'Neill, chief economist in London at Goldman Sachs Group Inc., the most profitable securities company, said last week the narrowing trade deficit will help revive the dollar's allure. Goldman had predicted that the dollar would weaken as U.S. growth slowed while the rest of the world expanded.
Lower rates may work to the dollar's advantage by stimulating growth, said Michael Woolfolk, senior currency strategist at the Bank of New York Mellon, the world's largest custodial bank with over $20 trillion in assets. The ECB and BOE may have to cut borrowing costs as their economies feel the pinch of previous rate increases, putting pressure on the euro and the pound, he said.
``The U.S. economy will recover,'' said Woolfolk, who is based in New York. ``The financial sector will begin to show signs of recovery. The dollar will continue to stabilize and even rebound.''
To contact the reporter on this story: Min Zeng in New York at mzeng2@bloomberg.net .
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