Submitted by Econbrowser

Some analysts think so.

I’ve gone through some earlier forecasts to see what they’ve indicated about market views of the dollar’s trajectory.

Figure 1: Log nominal broad trade-weighted value of the dollar (blue), and implied forecasts for dollar value for July (red triangles), September (green circles), October (purple squares) and November (teal diamonds). Source: Fed, Deutsche Bank Exchange Rate Perspectives, various issues, and author’s calculations.

The broad trade-weighted value of the (nominal) dollar in blue has clearly been declining. In July, before the onset of the asset-backed corporate paper market experienced its first bout of turmoil, dollar depreciation was anticipated over the longer horizon (red triangles), but only about 4% in log terms by August 2008 (these are Deutsche Bank forecasts, but my impression is that these forecasts are not too different from market consensus). The dollar depreciated much faster than anticipated, so that by September 2008, the dollar’s value against a broad basket was about what was expected for February. Expectations were revised in September (green open circles) to anticipate a depreciation over the next three months, with stabilization thereafter. October’s forecast projected slight appreciation, as the dollar dropped over 2% from its September value. Finally, in Mid-November, with the dollar lower by over another percent, the predicted path of the dollar (green diamonds) was still largely unchanged relative to October (and even September) forecasts.

[One caveat is that I am assuming the DB dollar index is similar to the Fed’s broad trade weighted index, and used the projected changes in the DB dollar index to impute the projected change in the Fed’s broad index. Over the period of focus (July to November 2007), the Fed narrow and broad indices move in a similar fashion, although the narrow index moves down slightly faster.]

So, it would seem that the market does believe there is a floor beneath which the dollar will not fall. I suspect this is based mostly on a view about where interest rates are going in the euro area, and other major industrial-country economies (not an unreasonable approach; see this post). This definitely makes sense from a Taylor rule perspective on exchange rate fundamentals, as discussed in Engel-West, and Molodtsova and Papell, for instance.

These forecasts we see (both here and elsewhere) are measures of central tendency, which are (tautologically) going to ascribe low weight to low-probability events. And this is where Brad Setser’s observation that the depreciation-to-date has mostly been against floating currencies. If the central banks that peg or tightly manage their currencies diversify slowly, then these forecasts with a floor on the value of the dollar still make sense. If there is a set of discrete breaks in dollar pegs (think the GCC countries), then one could imagine the floor on the dollar being somewhat lower…

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