It is Time to Go Long the Dollar?

Anyone who has been closely following the foreign exchange market lately must have been aware of the gradual strengthening of dollar against world's other major currencies in the last few days. The dollar has gained an impressive 650+ pips against euro, ever since it hit a low on 22nd April (the euro traded at 1.6018 against dollar). The gain has been especially sharper in last few trading sessions, wherein the dollar has gained close to 500 pips against the euro in the last 5 days and is trading at its one month high. On Friday the 13th, the U.S. dollar will be finishing with the its biggest weekly gain in 3 years . The U.S. currency climbed 2.5 percent this week against the euro, the biggest increase since June 2005. The dollar also rose 2.9 percent versus the yen, the most since December 2004. Apart from it, the U.S. dollar gained 2.5 percent against its Australian counterpart, the biggest gain in 3 months and 2.3 percent against the New Zealand currency.

So what exactly has brought back the faith in dollar? What interests us the most is that a relatively quieter rebound in dollar is being witnessed at a time when the U.S. consumer price index increased by 0.6 percent in the latest quarter and when crude oil has been hitting newer high each day. Well, seen from a different perspective, a higher than expected U.S. CPI data only ended up helping the dollar's cause. One week ago, the likelihood that the U.S. Federal Reserve would raise its benchmark interest rate at the Aug. 5 meeting was zero, according to fed funds futures prices. Now, the odds are better than 65 percent.

Moreover, a few days ago, Ben Bernanke made it clear that the Fed is "attentive'' to the currency and will guard against a jump in inflation expectations. A weak dollar, according to Bernanke contributes to an  "unwelcome rise'' in inflation. Speaking to a conference in Barcelona, he said Fed and Treasury officials are collaborating to "carefully monitor'' exchange rates. "The risk that the economy has entered a substantial downturn appears to have diminished,'' Bernanke said in a speech at a Boston Fed conference on June 9. Earlier, Paulson began strengthening the U.S. stance in November only by stating that the dollar would reflect solid long-term economic fundamentals.

Agreed, European Central Bank is very hawkish when it comes to monetary policy, but the Federal Reserve's shift to fighting inflation makes the latter likely to raise interest rates more aggressively than the European counterpoint. According to the latest Fed fund futures, the market has already priced in a 67 percent chance of a 25bp rate hike in August and a 97 percent chance of a rate hike in September.

Recently released U.S. indicators like retail sales, housing data, payroll figures etc. have shown signs of improvement. Especially in retail sales, the jump has been quite encouraging, though job market still needs some time to normalize. The tax rebate plan seems to have worked well with the economy. Have a look at some of the data released in last two weeks which have beaten analysts' estimates and market expectations by wide margins.

Also, the supply of dollars is falling as the U.S. current account deficit improves. Because the major currencies are free-floating, prices are determined in the market based on the global supply and demand for a particular currency against another. And one of the major sources of supply of U.S. dollars is through the U.S. current account deficit. Now, the U.S. current account deficit is improving. That means less dollars in global markets, which should help the buck's value.

the G7 is also seen as adopting a hard stand on the dollar front. Finance ministers and central bankers for the group of major industrial nations said April 11 that "sharp fluctuations'' in exchange rates had ``implications for economic and financial stability.'' Moreover, G-8 finance ministers recently made it clear that the credit squeeze has been replaced by surging food and fuel prices as the biggest threat to the world economy. European officials also have expressed concern at the euro's climb versus the dollar. European Central Bank board member Christian Noyer said "one can hope'' the gap between the euro and the dollar may narrow, in an interview published Monday in Forces, a Canadian magazine. "Markets often push currencies beyond the ranges in which we'd like to see them,'' Forces quoted him as saying. Jens Nordvig, a Goldman Sachs Group Inc. currency strategist in New York says``If we had another big dollar leg down, I think it would raise the possibility of intervention,'' said . The "more immediate implication'' of Bernanke's speech is that "the threshold for Fed easing is higher than might otherwise be the case'' should the economy weaken later in the year, he said.

The last time the major industrialized countries intervened was on Sept. 22, 2000, when they bought the euro after it tumbled 27 percent from its 1999 debut. They last propped up the dollar in 1995, when it sank almost 20 percent in four months against the Japanese yen to a post-World War II low of 79.95. Central banks intervene in currency markets by arranging purchases or sales of foreign exchange.

Moreover, the 15-nation euro is showing the sign of weakness as Irish voters turned down the European Union's new treaty, a setback for the bloc's plans to strengthen its global voice. Results from yesterday's national ballot on the Lisbon Treaty show opponents defeated supporters by 53.4 percent to 46.6 percent. "The rejection of the treaty undermines the EU's public legitimacy and may influence public sentiment in countries contemplating joining the euro zone,'' wrote Geoffrey Yu, a currency analyst at UBS AG, in a note to clients today. "This change may undermine the ECB's price stability mandate in favor of a growth mandate.''

Going by recent indications, we may soon see commodity prices, especially crude oil correcting from their current levels. OPEC has made it clear that the current price levels are unjustified when seen in the light of fundamentals. Also, countries like India, Taiwan, Malaysia and Indonesia have slashed the subsidies on petroleum product, which again doesn't spell too well for crude oil, as it has the potential to partially destroy the crude oil demand. A lower crude oil price is again a good news for dollar. According to Bloomberg calculations based on value changes, the dollar falls against the euro 93 percent of the time when oil rises.

Whatever may be the case, dollar bulls are still in the minority as the picture has yet to become clearer. Traders are still hesitant to enter long in dollar in a big way The data coming from U.S. is still by and large fairly inconsistent. U.S. housing and labor market still needs lots of improvement. Same goes for the banking sector. Lehman Brothers' (LEH) results which is soon going to be declared, has the potential to once again derail dollar's rise. However, going by the sentiment, much of the pessimism already seems to be priced.

The last two major bear markets in the U.S. dollar lasted seven years. The current bear run in the dollar is soon going to complete its seventh year. According to a latest Bloomberg survey, the currency will strengthen 2.5 percent to $1.50 per euro by year-end.

Thus, in the light of above arguments, it seems pertinent that the dollar may soon embark on an upward rally. So am I betting my money on a dollar rally? Well, it's beginning to look that way.

Comments

[bbzz24]

You pubished this article at at time when 2/3 of the touted gains has gone away and has not revised it to reflect the reality of last couple of weeks. You deserve an F.

[waldipup]

I hate to say "it's different this time " , because that is an amateur mistake to make.

But I will say that if your position is being attacked , you can shoot back and drive off the enemy over and over again -

Until you have run out of ammo.

Then , I would take the liberty of saying , upon the next attack , that

"It's different this time" .

See if you can draw any similar inferences per the "two previous 7 year rallies in the dollar " , to now.

[John Booke]

"Decoupling" from the US is a myth. The dollar will rise when other developed economies can't sell more stuff to US consumers. That's happening now.

[Melancholy Korean]

Agree with the first commenter. At first I thought I was reading, by mistake, an article from a few weeks ago. If you are claiming a "long term" shift, well, I agree with you that the dollar is one of the few assets not overvalued these days. But trading is about timing, yes?

And the timing has gotten a lot trickier since the Fed and ECB are playing games and are themselves confused about what to do. "Murky" is right.

Your article doesn't help to clarify any of the confusion.

[sieraromero]

what a bunch of garbage! why do you think the government quit publishing the M3 figures? the world is awash in worthless dollars. we can't intervene meaningfully--we have less foreign currency reserves than Poland !

[turbotom]

I cant help wondering. Who ownes all the gold at fort Knox. Not the Fed? If so, why isnt anyone suggesting selling gold for dollars and taking them out of the market. The mere threat of selling the tons of gold would boost the buck. No?

[B. Ray]

>>Also, countries like India, Taiwan, Malaysia and Indonesia have
>>slashed the subsidies on petroleum product, which again doesn't
>>spell too well for crude oil, as it has the potential to partially
>>destroy the crude oil demand.

don't forget to add China. They increaed their retail gas price by 18% lst month.

[Gross Bill]

Originally published JUNE 13....real timely Seeking Alpha. Again, consider the name change to "Seeking Filler."

[Shira Jacobson]

Thanks for bringing that to our attention. We've backdated the post to its original publication date.

Regards,

Shira Jacobson
Seeking Alpha Editorial Team

[carey_jim]

I think your analysis is right but the answer to your question: "Is it time to go long on the dollar?" is "probably" no.

The dot com bust, the real estate bust and even the precipitous fall of the dollar against the Euro was predicted by the majority of financial analysts, from The New York Times and Economist all the way to the business pages of the local newspapers.

But their timing was usually a few years early.

There are also several wild cards in the deck: the Iraq war is one. The real estate market and banking and financial system are the other two. Other wild cards are more obscure but just as threatening.

[User 30121]

You are off the mark by MILES!

Of course, I don't know if you did this piece "tongue in cheek", then its not even funny.