Dollar resurgence and emerging decline
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By Jeremy Gaunt, European Investment CorrespondentLONDON (Reuters) - Investors are likely to be wrestling this week with two new factors that have arisen to complicate an already tricky environment -- a sharp about-face in currency trading and signs of trouble in emerging markets.They will also be bracing themselves for the next wave of U.S. bank earnings, which begin in earnest next week, hoping that huge losses from the credit crisis are a thing of the past.Weekend news of U.S. government plans to take over Fannie Mae and Freddy Mac will add to the mix, with all shareholders of the two mortgage giants likely to take a hit, according to an influential lawmaker.A major financial story of the past few weeks has been the strengthening of the dollar against major currencies.The so-called dollar index <.DXY>, a measure of the greenback against six other currencies, has risen in seven of the past eight weeks and is on track for its largest quarterly percentage gain since the fourth quarter of 1992.Britain's pound has been particularly hurt by the shift, falling rapidly to levels against the dollar last seen 2-1/2 years ago, around $1.76. But the euro, too, has fallen and now trades around $1.42 compared with $1.60 in mid-July.For equity investors, these kind of moves can have a significant impact on returns, especially in a climate of falling or weak stock markets."Equity investors typically don't hedge the currency risk," said Michael Metcalfe, head of global macro strategy at State Street Global Markets. He noted that at the end of 2007, U.S. investors held as much as $5.3 trillion of foreign equities.Dollar strength would mean conversion back from euros, pounds etc, could be costly, prompting investors to try to repatriate profits in case the trend continues.Conversely, Metcalfe also notes that a stronger dollar may put off overseas investors, including huge central banks, from buying U.S. assets. He noted that custody holdings of U.S. Treasuries had begun to fall in the past month."That might be the first warning sign that dollar strength will lead to slow accumulation of dollar assets by central banks," he said.SLOWING EMERGINGA not altogether unrelated shift is also taking place on emerging markets, the once-booming asset class that is now under threat from slowing developed economies.Friday's poor U.S. jobs data showed the U.S. economy still suffering despite some recent upbeat data.Emerging market equities have been underperforming their developed counterparts for most of the year and are now coming under more intense scrutiny as the global downturn spreads.Emerging market stocks as measured by the benchmark MSCI <.MSCIEF> hit 17-month lows last week while spreads between emerging market debt yields and corresponding U.S. Treasury yields blew out to levels last seen in June 2005 when the index was adjusted to reflect Argentina's historic debt default."What we are seeing is some unwinding," said Klaus Wiener, head of research at Generali Investments in Cologne. "A falling tide lowers all boats."Underperforming emerging markets are having a number of effects on investors.First, they are stripping them of one of the most lucrative investments they have had over the past few years. The MSCI emerging index gained 326 percent between the ends of 2003 and 2007. It is down around 30 percent so far this year.Second, they are adding to the strength of the dollar as the mood swing against them encourages repatriation of investments.Thirdly, they are prompting investors to pick and choose carefully within this market. Commodity-producing countries are expected to come under increased pressure as commodity prices fall while others may not fare so badly.The Reuters-Jefferies CRB <.CRB> index of commodity futures has fallen for three months in a row after rising nine out of the previous 12.This does not mean, of course, that investors are giving up on emerging markets, just perhaps on the short-term outlook.Putnam Investments, for example, is launching new emerging market equity funds and says the long-term outlook for the asset class has not changed during the current market ructions.Matthew Scales, a senior Putnam investment product manager, said economic growth projections for emerging economies remain far more attractive for equities than do those for developed markets.BANKING AGAINInvestors, in the meantime, will be as keen as ever to track the U.S. economy, particularly after last week's jobs report and in view of the Fannie Mae and Freddie Mac bailout, an attempt to ward off further damage to the U.S. housing market."I think all shareholders will be disadvantaged," Rep. Barney Frank, chairman of the U.S. House of Representatives Financial Services Committee, told Reuters of the mortgage finance companies plan.Consumer sentiment figures will be reported on Friday, as will retail sales. The latter have held up quite well so far, in part because of tax rebates."It is questionable whether this trend will continue after tax rebates have run out," Swiss private bank Sarasin said in a note. "What might shore up retail sales is an expected retreat of inflation on the back of receding oil prices."But investors are not only concerned with the state of the U.S. and global economies. There are residual fears also about credit losses and their impact on the global financial system.For the latest on that, focus will start to grow this week on the latest raft of U.S. bank earnings, which begin next week.Goldman Sachs , which has weathered the storm well so far, reports on September 16.Lehman Brothers has yet to announce a formal reporting date, but it will be in the limelight when it does.The cost to insure Lehman debt rose last week amid doubts about the likelihood of an acquisition of the investment bank by state-controlled Korea Development Bank .(Editing by Hans Peters and Quentin Bryar)
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