While it is dangerous to read too much into short-term movements in the foreign exchange market, the intense downward pressure on the US currency since late October appears to mark a new phase in the dollar bear market following a respite in the second and third quarters of this year. It would also create strains in the world's financial system owing to the large stocks of US Treasuries and other dollar assets in the hands of foreign central banks and commercial banks. This scenario would exacerbate problems of excess capacity in the world economy, given the central role played by the US in sustaining global demand in recent years. However, there is a risk that the decline in the dollar could become disorderly, triggering a larger than expected rise in US Treasury yields and a sharp slowdown in US demand. This will contribute to a gradual unwinding of global imbalances over the medium term. Our view is that further depreciation of the dollar is prospect, accompanied by a rise in US Treasury yields and a softening of US demand. The Economist Intelligence Unit today discusses the weakness of the dollar and the implications that it has for the US trade and current account deficits, US Treasury yields and the outlook for the world economy in 2005.
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