Sept. 8 (Bloomberg) -- For the first time in at least two years, deficits are starting to matter to currency investors, and that may be bad news for the dollar. While the trade-weighted Dollar Index fell 2.2 percent in the past two years as capital markets froze, the budget gap reached $1 trillion and the economy sank into the deepest recession since the 1930s, traders are now banking on a longer- term decline. Forward contracts show the greenback weakening to $1.49 per euro in the next 10 years, compared with an average of $1.17 since the single European currency was introduced in 1999. The budget and current-account deficits are coming back into focus as President Barack Obama’s stimulus measures revive the economy, reducing demand for the relative safety of U.S. assets. The JPMorgan G7 Volatility Index measuring perceptions of risk fell to the lowest level in a year. Morgan Stanley currency strategists said in a Sept. 3 report that “economic data releases are now more important for FX daily moves than in the past four years.” “As the normalization of the markets has taken place, the market starts to differentiate currencies,” said Paresh Upadhyaya, a senior vice president at Boston-based Putnam Investments who helps manage $21 billion. He turned bearish on the U.S. currency in April. “You have to be negative on the dollar.” Deficit Forecast Economists forecast the current-account deficit will rise to 3.2 percent of gross domestic product in 2010 and 3.5 percent in 2011 from 2.9 percent this year as consumer and business spending boost imports and oil prices increase, according to the median estimates in Bloomberg News surveys. Europe’s deficit will account for 1.2 percent of GDP, a separate poll shows. The budget deficit reached a record $1.27 trillion in the first 10 months of fiscal 2009 ending Sept. 30 as the recession curbed tax receipts and the Obama administration increased spending. The gap will grow to $1.6 trillion in fiscal 2010 before narrowing to $1.4 trillion the following year, according to the Congressional Budget Office. “We are at a cross-road,” Kenneth Rogoff, a Harvard University professor and former chief economist for the International Monetary Fund in Washington, said in an interview last week. “If the Obama Administration fails to rein in the long-term budget deficits, the dollar is set to decline for decades.” Trade Balance The Commerce Department will report the trade balance for July on Sept. 10. The median estimate of 62 economists surveyed by Bloomberg is for a deficit of $27.3 billion. While that improved from $64.9 billion a year earlier, it’s been little changed since February. Trade feeds into the broader current-account balance, which includes transfer payments and investment income and stood at a negative $101.5 billion in March. While the gap has narrowed from a record $214.8 billion in September 2006, it’s still above the average of $63.2 billion over the past 30 years and means the U.S. needs to attract about $1 billion a day in new foreign capital for the dollar to maintain its value. Dollar bears note net purchases of long-term U.S. securities by foreign investors fell below the trade deficit by $46 billion in the first half of the year, one of the only three occasions since 1994 there was a shortfall, according to Treasury Department data. ‘Huge Financing Need’ When that happened in the second half of 2007, the Intercontinental Exchange Inc.’s Dollar Index, which measures the currency’s performance against the euro, yen, pound, Canadian dollar, Swiss franc and Swedish krona, fell 6.38 percent. “The U.S. has such a huge financing need that you wonder what level of the dollar that will require,” said Emanuele Ravano, a managing director in London for Pacific Investment Management Co., which oversees more than $840 billion. “The dollar will need to weaken” to attract investment, he said. Pimco has been calling for a weaker dollar since before credit markets seized up in August 2007. Wagers by hedge funds and other large speculators against the dollar versus eight major currencies rose to 217,367 contracts on Aug. 25, the most since July 2008, figures from the Washington-based Commodity Futures Trading Commission show. As recently as April, traders were betting the dollar would gain. Pulling Back The Dollar Index fell at the start of the credit-market seizure two years ago, dropping 13 percent to a record low in April, 2008. It rebounded 25 percent by March as the collapse of Lehman Brothers Holdings Inc., the bailout of American International Group Inc. and the forced sale of Merrill Lynch & Co. sparked concern the global financial system was close to collapse, driving traders to the perceived safety of the U.S. currency and government debt. The index has since retreated 14 percent and closed Sept. 4 at 78.136 as financial markets stabilized and the Standard & Poor’s 500 Index surged 49 percent in the biggest rally since the 1930s. It fell to 77.234 today, down 5 percent this year. The dollar declined 1 percent to $1.4479 per euro as of 6:52 a.m. in New York, and depreciated 0.9 percent against the yen to 92.22. Concerns about the dollar’s performance are overblown, said Christoph Kind, who manages $20 billion as head of asset allocation in Frankfurt at Frankfurt-Trust Investment GmbH. Savings Rate Increased savings will make the U.S. less dependent on foreign capital, he said. Americans saved 6 percent of their incomes in May, the highest level since 1998 and up from zero in April 2008. The rate fell to 4.2 percent in July, in line with the average over the past 20 years. “The U.S. is not going back to the old model of growth,” where Americans used borrowed money to buy foreign goods, said Kind. “The new growth model will be more export-led. From that point, the narrowing in the current-account deficit will begin, which is positive for the dollar.” King is “overweight” the dollar, meaning he owns a greater percentage of assets denominated in the currency than is contained in benchmark indexes. The median estimate of 33 strategists surveyed by Bloomberg is for the greenback to end 2010 at $1.40 per euro. Bond yields may also help the dollar. The 10-year U.S. Treasury note yielded an average 3.34 percentage points more than the Fed’s target rate for overnight loans between banks during the last three months. Whenever the gap approaches 4 percentage points, U.S. debt becomes “hugely” attractive to foreign investors, according to Alan Ruskin, head of currency strategy at RBS Securities Inc. in Stamford, Connecticut. Dollar and Spreads The Dollar Index gained 6.56 percent in 2001 as the spread reached about 3.65 percentage points. The 10-year yield will rise to 4.39 percent by the end of 2010, as the Fed’s target rate for overnight loans between banks increases to 1 percent, according to the median estimate of more than 45 economists and strategists surveyed by Bloomberg. “The combination of a large public sector deficit that pushes up market-determined real and nominal yields, with a relatively small external financing need, may well be associated with a reasonably strong currency,” Ruskin wrote in a research note to clients on Aug. 19. Harvard’s Rogoff and Maurice Obstfeld, a professor at the University of California Berkeley, predicted in November 2005 that the dollar would need to depreciate as much as 30 percent on a trade-weighted basis to close a current-account deficit totaling 6 percent of GDP. The Dollar Index is down about 15 percent since then. Emerging Markets Benefit Now, Rogoff says the dollar will decline against emerging market currencies by about 2 percent each year for the next 10 years as the developing world economies account for a larger share of global growth. To keep the dollar from depreciating, the U.S. current-account deficit should be no larger than 2 percent or 2.5 percent of GDP, he said. As Obama pushed the nation’s marketable debt to $6.78 trillion, the country became more reliant on foreign funding. Almost 50 percent of the debt is held outside the country, up from 35 percent in 2000, U.S. figures show. International investors have reduced purchases of long-term U.S. assets in recent months, according to the Treasury Department. Net inflows into Treasuries and stocks fell to $82.8 billion in the second quarter from $235 billion a year earlier, a 65 percent decline. No ‘Performance Advantage’ The need for foreign investors may only increase in the final four months of 2009. After purchases by the Fed, the net supply of long-term U.S. government and agency debt has been about $50 billion a month this year, Dean Maki, head of U.S. economics research at Barclays Capital in New York, wrote in a Sept. 4 report. As the Fed slows its so-called quantitative easing program, net supply may reach $200 billion by year-end, he wrote. “In the broadest sense, the dollar tends to prosper when a unique U.S. asset attracts foreign buyers,” such as high real yields in the early 1980s and the Internet boom in early 2000s, Steven Englander, the chief currency strategist at Barclays, wrote in a research note on Aug. 27. “There is no asset class in which U.S. assets have a clear performance advantage”

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