A Different Debt Problem May Burden Dollar

ByStander

NEW YORK—Contentious U.S. deficit negotiations may pressure the dollar this week, momentarily diverting attention from Europe's debt crisis.

The main event in a Thanksgiving holiday-shortened week will be Wednesday's deadline for a debt-reduction deal by the bipartisan supercommittee. The U.S. lawmakers' task of finding $1.2 trillion worth of savings over 10 years has taken on added significance in a market that has been singularly obsessed with the 17-nation euro zone's debt maelstrom.

Despite fears about euro-zone debt, by week's end the flow of investors into the relative safety of the greenback had all but evaporated. The euro recovered a full cent from a one-month low at $1.3421 hit Thursday to trade at $1.3524 late Friday in New York.

Analysts are divided on how significant the deficit committee's decision—or lack thereof—will be for the dollar. While ultralow borrowing costs and large government deficits loom as a long-term risk, Europe's debt crisis is widely considered to be the more immediate problem.

This is especially true now, given that recent data suggest the U.S. economy is successfully warding off a new recession.

"Relative growth differentials should still work in favor of the dollar, if you remove the overcast of the euro zone's problems," said Andrew Wilkinson, chief economic strategist at Miller Tabak & Co. He said he thinks the supercommittee should be a "low-risk event" for the dollar as long as Europe's woes keep investors holding dollars for safety. But he added that the greenback could fall if European policy makers find a credible way to alleviate the financial distress of Spain, Italy and Greece.

Yet Steven Englander, Citigroup's head of G-10 currency strategy, said he thinks the congressional committee could remind investors of the stormy August debt-ceiling negotiations. He sees the dollar as vulnerable to any outcome that resembles a half-measure to address U.S. debt—especially in a market that seems to be factoring in the chance of a third round of quantitative easing by the Federal Reserve, which also tends to weaken the dollar.

"A lot of investors think the Fed will use euro-zone weakness to do QE3: they kind of see it as a joint product," he said.

As Fed officials have consistently played down stronger-than-expected data while playing up risks to the economic outlook, "you know they're teeing up something," he added.

William Dudley, the president of the New York Fed, on Thursday became the latest Fed official to express unhappiness with the pace of recovery. He said he was "deeply unhappy" with high unemployment. Mr. Dudley, one of the growth-supportive doves that dominate the Fed's policy-making committee, said the Fed would weigh whether "there is more that we could do that would bring more benefit than cost."

The week's data will include the second report of third-quarter U.S. gross domestic product, which could confirm the market's optimistic view about the economy or give the Fed new reasons to prepare the market for a third round of easing. Also on tap are reads on November consumer sentiment and October durable goods orders.

In the absence of major news, the euro is being held aloft on little more than faint optimism. A near inexorable rise in Italian bond yields, which pierced 7% again last week before falling back Friday, has raised fears that the euro zone's third-largest economy could find itself undermined by unsustainable borrowing costs. Analysts generally consider a sustained break above 7% yields to spell trouble.

Bond yields in Spain, the euro zone's fourth-largest economy, are also on the rise and flirted with 7% last week. National elections Sunday were expected to sweep the ruling Socialist party from power. Market watchers will keep a close eye on the country's bond yields when markets open for trading Monday.

But investors continue to hope the European Central Bank's buying of distressed debt will buy enough time for policy makers to forge a lasting solution to the Continent's woes.

Elsewhere in the currency market, the dollar was at ¥76.91 late Friday, down fractionally from ¥76.98 late Thursday. The U.K. pound was at $1.5803, up from $1.5755. The dollar was at 0.9168 Swiss franc, down from 0.9220 franc.