Bernanke Holds The Dollar In His Hands

Includes: UDN, UUP
by: Tim Clayton

Currency weakness remains firmly in fashion as policy-makers continue to adjust to the perverse post-crash environment. Although notionally committed to inflation targets, central banks increasingly have effectively been mandated to seek weaker currencies rather than price stability. The Federal Reserve is likely to keep the quantitative easing carrot within peripheral vision which will also act as an important constraint to dollar gains even with a slightly more confident statement.

The Fed will stay on guard and be ready to stamp down on any signs of excessive dollar bullishness. The global policy risks still make buying US currency dips remains the best strategy, but patience will certainly be required.

The Bank of Japan and Finance Ministry will act to block any appreciation of the yen. French President Sarkozy has been pushing for a weaker euro while the Chinese move to expand the yuan trading range is actually a smokescreen designed to prevent currency gains. Brazil and India both cut interest rates last week, in part aiming to prevent any currency appreciation, while the Swiss National Bank is openly committed to blocking any euro gains. This determination to block gains has given an unexpected gloss to currency weaklings such as Sterling.

Policies of competitive devaluation inevitably have a very poor historic track record as potential gains are quickly cancelled out through a zero-sum gain with the net result of higher inflation and unemployment. Markets need an anchor and gold bugs have inevitably promoted the merits of a return to the gold standard, but this is a remote possibility at best.

Markets will, therefore, be looking for the US Federal Reserve to show its credentials. With the US economy at least out of intensive care, the Fed has the opportunity to accept its global role. Any commitment to dollar stability and would be vital in boosting global economic confidence and lessen the threat.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.