The Dollar Rebound and What It Means to the Market

by: BubbleBustInvesting

By Panos Mourdoukoutas

After being in free fall for close to two years, the dollar is turning around, gaining against every major currency, especially against the euro. Is it just noise or a genuine trend?

We do believe that it is the second, for four reasons:

1. Monetary policy shift in the US. In its press conference two days ago, Fed Chairman Ben Bernanke made clear that, unless the economy weakens significantly, there will be no more QE3, so there will be no pressure to further lower long-term rates, which is bullish for the dollar.

2. Fiscal policy shift in the US. In recent speeches, legislators from both parties have expressed determination to address the country’s soaring debt, which is bullish for the dollar.

3. Flight to quality. With sovereign debt issues persisting in Europe, the US treasuries continue to be the safe investment for foreign investors, also bullish for the dollar.

4. Monetary tightening in emerging countries may be over. Monetary tightening has begun to slow down inflation and economic growth in emerging markets, which is bearish for those currencies.

What does an uptrend for the dollar mean for financial markets?

While a stronger dollar may be beneficial for US equities in the long-term, it is a negative for the overall market in the short run, as investors have begun to unwind long positions, especially the sectors that benefited from the falling dollar:

1. Overall market. Shortly after the Fed conference, the overall market began to decline with SPDR S&P 500 Trust (NYSEARCA:SPY) losing close to 3 percent of its value.

2. Commodities. Oil, silver, and gold are particularly vulnerable. Shortly before the close of the market closed on Friday, SPDR Gold Shares (NYSEARCA:GLD) were down 1.46 percent, iShares Silver Trust (NYSEARCA:SLV) 2.65 percent, and proshares ultra silver (NYSEARCA:AGQ) 5.4 percent.

3. Exporters. Stocks of major US industrial and technology companies that draw a great deal of their sales from overseas are also vulnerable to a stronger dollar. Caterpillar (NYSE:CAT), for instance, lost 3 percent on Wednesday and another one percent on Friday. Cisco Systems (NASDAQ:CSCO) lost 2 percent on Wednesday and another 3 percent on Friday.

Disclosure: I am short GLD, SLV.