Uncertainty in Europe Could Halt Dollar's Decline

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Includes: FXE, IGOV, IRL, UUP
by: Nikhil Nichani

Things in the United States have been bad. Our Debt-to-GDP ratio is approaching 100%, the central bank is going on a printing spree, and companies are not willing to hire or lend. In the long run, the US is going to face some serious problems with its printing press, but the immediate problem right now lies in Europe. Earlier in the year, Europe was mayhem. Greece was on the brink of bankruptcy, and last minute efforts were being put together to save the country. With an approved austerity plan which faced harsh criticism from Greek citizens, many countries around the globe were able to provide Greece with the liquidity to push bankruptcy out of the picture. The euro, which fell to a two year low of below 1.20 against the dollar, rebounded up to above 1.40 recently.

But now concerns in Europe are rising again, as the fate of Ireland, Portugal and Spain remains uncertain. Ireland, which continues to pour money into its failed banking system, is the next in line that could possibly require a global rescue. After taking a breather in late September and early October, Irish bond yields have spiked up once again as the market starts to lose confidence in the country's debt. Portugal’s bond yields have also started to spike, setting a fresh 1 year high. With the current uncertainty in Europe, the euro has begun to collapse, now trading close to 1.37 against the dollar. This decline in the euro could set up for a possibly short term rally in the US dollar. The US Dollar Index, which is the broadest measure of the strength of the greenback, currently trades around 77.50-77.90. The biggest component of the index is the dollar exchange rate against the euro, making up close to 60% of the index. Any new event to further cast doubt on the liquidity of Ireland, Portugal, and/or Spain could put some serious pressure on the euro, which could in turn send the US Dollar Index higher and put a short term halt to the commodities and equities rally.

One way to play a possible rise in the US Dollar Index is through the PowerShares ETF UUP. UUP is the most popular ETF to trade the US dollar, with a current expense ratio of 0.75%. The USD, despite being artifically devalued by the Federal Reserve, is in range of a significant support level, and uncertainty out of Europe could be what it needs to head higher in the short term.

Disclosure: No Positions