Impact of revaluation on the $$$$ - if it happened

The Middle East May Still Be Considering Dropping Their Dollar Pegs

With the greenback trading near record lows, countries like Qatar and the United Arab Emirates are grappling with rapidly growing import price inflation and accelerated expansion as oil revenues rocket higher. In fact, during the third quarter of 2007, the Qatar Central Bank reported that inflation hit 13.7 percent (Qatar’s fiscal year ends on March 31). Meanwhile, the US Federal Reserve has reduced the federal funds rate by 300bps since September 2007 and the markets continue to price in additional cuts. Clearly, the synergies between the US and Persian Gulf countries have lessened quite a bit, making US monetary policy and more importantly, the US dollar, an uncomfortable fit for many Gulf Cooperation Council members, which includes Saudi Arabia, Bahrain, Kuwait, Oman, Qatar and the UAE. As a result, it is not surprising to hear that moving away from a dollar peg has been discussed by many of the GCC countries, but what are their options and how will it affect the US dollar?

Pegging to a Basket of Currencies – Persian Gulf countries like the UAE, Qatar, and Saudi Arabia have a few choices when it comes to shifting their respective currencies from the dollar peg, but they will likely want to go with a method that has been tried and tested by one of the other GCC member countries: Kuwait. In May, Kuwait shifted their currency, the dinar, from a dollar peg to a basket of currencies. While the exact weighting has not been disclosed, the basket likely remains heavily weighted in the greenback, with the remaining portions in the currencies of some of their major trading partners, including Europe, the UK, and Japan. Since the shift, the Kuwaiti dinar has appreciated over 9 percent, indicating that a move to a currency basket is a very feasible option. In the short-term, the announcement of a shift to a currency basket by any of the other GCC members would be detrimental to the greenback, as it would suggest that the country would start to diversify central bank reserves away from the dollar and into assets denominated in the currencies of the basket. There is significant capital at stake, as Saudi Arabia’s foreign currency reserves rose 26 percent in September from last year to $259 billion, while the UAE's reserves surged a whopping 65 percent in June from a year earlier to $43 billion. Furthermore, the risks of a sharp knee-jerk sell-off in the greenback would be exacerbated if a group of GCC members announced that they would all de-peg from the dollar, given the increased reserve diversification prospects.

A One-Off Revaluation – Another option that some of the GCC members may consider is a one-off revaluation, which would maintain the dollar peg, but at a level that reflects an appreciation of the local currency. This is similar to what China did with the yuan in July 2005, when the currency was allowed to appreciate 2.1 percent within a single day. The primary reaction of the greenback was seen as a 2.7 percent drop against the Japanese yen, but the sell-off of the dollar also followed through to a lesser degree of approximately 1 percent against the Euro and British Pound. However, the price action did not carry over into the long term, as the prevailing trends of the pairs eventually took over within a few days. If one or more GCC members chose to implement a one-off revaluation, we would likely see similar results where the US dollar would drop against the majors, though the sharpest moves would likely be against the Euro and British Pound. Nevertheless, with central bank foreign exchange reserves likely to go untouched for the time being, the sentiment may wane rather quickly.

http://www.dailyfx.com/story/topheadline/EUR_USD__Why_US_Dollar_Weakness_1206652408597.html