The New York Times July 12, 1998

A Great Big Bounce for Bucks & Bonds

by Gretchen Morgenson

Market Watch, Front Page Section

Like a beach ball held under water and then released, the dollar popped up again last week. The dollar index, a measure of the value of the Unted States currency against 10 major world currencies, reached a high on Thursday of 102.46, a level unseen since 1989. The index closed the week at 102.03.

Currency traders, concerned that the Treasury might intervene again on behalf of the Japanese yen and sell dollars, were cautious about the move. Was it a blip or the start of a long dollar uptrend?

“We’re seeing the birth of a new bull market in the dollar that won’t peak out until 2002,” said Martin Armstrong, chairman of Princeton Economics International, an advisory firm based in Princeton, N.J., that specializes in global economic issues.

Mr. Armstrong expects the dollar to hit 200 yen a year from now, up from 141.2 on Friday. And he expects the dollar to rally to 2.85 German marks, up from 1.82.

A strong dollar has implications for both stock and bond investors in the United States. Generally, a powerful currency is negative for stocks because it makes American goods more expensive overseas. Bonds meanwhile, are helped by a rising dollar as investors the world over buy United States Treasuries to benefit from the currency’s strength.

Last week, currency traders were waiting to see results of today’s parliamentary elections in Japan. But the elections will have little impact on the three bases for Mr. Armstrong’s forecast of a stronger dollar.

The first is Phase 2 of financial deregulation in Japan, set for Jan. 1,1999, which will free Japanese pension funds to invest in instruments other than Japanese Government bonds. Because confidence in Japan’s institutions is so low, and interest rates are less than 1 percent, the managers will find United States Treasuries attractive.

Mr. Armstrong says discussions with some of these managers lead him to expect that 15 percent of the $9 trillion invested will head for the United States bond market. That’s more than $1 trillion. “The Japanese have the potential to be to the U.S. bond market what the Hunt brothers were to silver,” he said, referring to the Texas investors.

This flood of funds, he says, will drive long-term United States interest rates to 4.75 percent from today’s 5.62 percent. Funds will begin flowing in January; more will come in April, when Japan’s fiscal year begins.

The second prod to the dollar relates to the economic meltdown in Russia. United States exposure is relatively small: of the $70 billion in loans to Russia, 10 percent originated here. Most came from Europe—$30 billion from Germany alone.

Finally, the dollar will benefit from the chaos surrounding the introduction of the euro, the single European currency, next year. “Capital is pouring out of Germany,” Mr. Armstrong said. “They have figured out that the value of the euro cannot be the value of the strongest currency in the basket. So they’re moving out capital as a hedge.” Where is it going? To the United States.

It all adds up to a mighty dollar and a bull move in bonds. As for stocks, Mr. Armstrong thinks European markets, up more than 35 percent this year, are very vulnerable. United States markets, concerned about the dollar’s climb and the upheaval in Russia, may decline later this summer, he said. But Mr. Armstrong doesn’t expect a correction greater than 20 percent. “With U.S. interest rates coming down,” he said, “equities will recover.”