Twin deficits: declining

Analysts say the U.S.'s now shrinking "twin deficits" -- the budget deficit and trade deficit -- will support the dollar's recovery.

The United States budget deficit for fiscal 2007, which ended September 30, 2007, dropped to $162.8 billion, according to the U.S. Treasury Department. Many analysts expect the budget deficit to fall to $135-$150 billion in fiscal 2008. The budget deficit is down from $413 billion in 2004. Meanwhile, the trade deficit is also declining, dropping to $56.5 billion in September 2007 after hitting $67.6 billion in August 2006, according to U.S. Commerce Department data.

Independent currency trader Andrew Resnick, formerly of Next Capital of New York, told BloggingStocks on Monday that the declining twin deficits mean that fewer dollars are needed to execute important elements of the U.S. economy.

"It's the law of supply and demand. With a smaller budget deficit, we need fewer dollar-based investors to finance the deficit, and with the smaller trade deficit, fewer dollars are being converted into other currencies. Each is bullish for the dollar," Resnick said. "If the [U.S.] economy performs OK in 2008, that will keep U.S. investments, such as stocks, attractive to foreign investors, which should also help the dollar."

Fed is a factor

However, Resnick was quick to add that a third factor may complicate the potential dollar recovery in 2008: the U.S. Federal Reserve. The Fed has twice lowered key interest rates this year and is expected to cut rates again when it meets December 11. The Federal Funds rate, which banks charge each other, now stands at 4.50%, and the discount rate, the rate the Fed charges banks for short-term loans, is at 5.00%. Meanwhile, the European Central Bank and the Bank of England have kept their key interest rates unchanged at 4% and 5.75%, respectively.

"If the Fed moves forward with its next interest rate cut, as expected, that would work against the dollar," Resnick said, and set up a clash of investment climates: "dollar bears," who think Europe's higher interest rates will rule the day, vs. "dollar bulls," who see reduced-cost U.S. exports and the U.S. investment climate winning in 2008."

"For 2008, the dollar bulls have the edge, with a dollar recovery through at least the first half of 2008," Resnick said.

Euro to $1.35?

Resnick said the dollar could improve to $1.35 versus the euro and to 120 yen against the yen, if 2008 U.S. GDP grows by 2%. Further, the dollar could improve to $1.30 against the euro, if oil drops further, to around $70 per barrel. Oil traded Monday afternoon down 84 cents to $87.87.

"Oil below $70 will help two ways, by reducing the U.S. trade deficit and by stimulating U.S. economic growth," Resnick said, adding that both of which would be dollar-supportive.

"The trends are lining up for the dollar to have its first good year in a while in 2008," Resnick said.