The Dollar Will Continue to Appreciate against the Euro

The common European currency will be worth almost $1 in June 2011, predicts Vincent Chaigneau, head of foreign exchange and interest rate strategy at Société Générale.

Is there a chance that American long-term rates will increase?

Yes. In spite of market pressures, the American government doesn’t seem determined to get its public finances in order. Our models show that to reduce its debt down to 60 percent of GDP in 2030, the United States will have to produce — over several years — a budget equivalent to 12 percent of GDP. It’s the highest rate of all the countries in the OECD (except Japan). Without a doubt, the American government is thinking of filling the hole in its public finances with a return to growth. Unfortunately, it’s mistaken. According to our forecasts, the interest linked to debt could represent 15 percent of the budgetary formula in 2013. Another concern for American public finances: the country will have very high expenditures due to the aging of the population in the medium term. Indeed, American long-term rates will have to climb to four percent at the end of 2010 and five percent at the end of 2011 (compared with 3.3 percent today).

Will the increase in long-term rates be accompanied by a depreciation of the dollar?

No. On the contrary, the dollar will appreciate against the euro. Actually, there is doubt about the permanence of the monetary union. The euro is worth 15 percent less that its theoretical value, lying in the neighborhood of $1.40, and the central banks don’t seem ready to intervene to stop the trend, contrary to what happened in 2000. The other factor that has a chance of pushing the dollar higher is the monetary policy of the United States. The Fed could begin to raise its key rate from 25 basis points in December 2010. But then, in order to avoid past errors (its slowness contributed to the swelling of the real estate bubble), it may press down hard on the monetary break, while driving its key rate back up 150 basis points in six months. Ultimately, we can count on a euro that is close to $1.10 in June 2011 (compared with $1.23 today).