By Closing Above Its 'QE2 Reference Price', Dollar Increases Pressure On Fed

Includes: CAT, GLD, GWW, INTC, UUP
by: Dr. Duru

I did not think it would happen, but the dollar index finally closed above its "QE2 reference price." The QE2 reference price is where the dollar index stood right before the Federal Reserve telegraphed QE2 in late August, 2010.

Weekly chart shows dollar index closing above the QE2 reference price for the first time in two years

Weekly chart shows dollar index closing above the QE2 reference price for the first time in two years

I have contended that if the dollar index reached current levels, the Federal Reserve would feel even more pressure to do something to drive the dollar back down. The strong dollar is applying increasing pressure on the financial results of companies with business overseas. I am noting in the earnings reports of several companies that a strong dollar has become a small burden on sales, revenues, and/or profits. Intel (INTC) noted in its most recent earnings call that the strong dollar is driving up the prices of computers in some countries (from Seeking Alpha transcripts):

"In some of the countries we're seeing the prices of computers go up as a result of the currency fluctuations against the dollar. Most PC components including ours are sold globally in dollars, and the PCs are typically priced in dollars. So - at least to the distributors in those countries, so the price goes up as the currency changes."

Here is W.W. Grainger, Inc (GWW) an international parts distributor (from Seeking Alpha transcripts):

"…if economic growth slows and the dollar continues to strengthen, the lower end of our sales range is more probable than the higher end. If that happens, we plan to reassess and adjust spending levels…

…we now expect foreign exchange to be a headwind on both the top and bottom lines for the full year. Given the relative strength of the U.S. dollar, foreign exchange could represent as much as a 1 percentage point drag on sales and $0.04 to $0.06 per share in earnings dilution for the year."

Finally, here is Caterpillar, Inc. (CAT), an international heavy machinery company, in its earnings report from July 25th:

"Since the introduction of our outlook in January of 2012, the U.S. dollar has strengthened and has negatively impacted our sales and revenues outlook as our sales in currencies other than the U.S. dollar are translating into fewer U.S. dollars."

Fortunately for CAT:

"Currency had little impact on the change in the profit-per-share outlook from $9.50 to $9.60 because of the offsetting impact on sales in the worldwide markets we serve with costs resulting from our extensive global manufacturing footprint and cost base. The outlook for 2012 reflects full-year records for sales and revenues and profit."

It is very telling that CAT claims that it has "…not detected much benefit to economic growth from the central bank's policy of lengthening the maturity of its securities." Indeed, the company expects "…the U.S. Federal Reserve will resume expanding its balance sheet…"

I believe the Federal Reserve is taking note of these pressures as it surveys its contacts in industry. The expectation for Fed action is not unique to Caterpillar . Even the stock market's resilience in the face of declining global economic prospects seems to rest on the expectation of imminent Fed action.

One corner of the financial universe has not shown much anticipation for renewed weakness in the dollar: gold. Gold remains locked in a general downtrend from its peak last year although it seems to have found support over this time as well. Interestingly enough, gold perked up even as the dollar rose to its new milestone. Perhaps early signs of a belated response to potential Fed action? Difficult to say, but certainly very plausible given markets can be very inefficient.

Despite dollar strength, gold manages to perk up in the middle of its recent trading range

Despite dollar strength, gold manages to perk up in the middle of its recent trading range

Source for charts:

Regardless, Federal Reserve will very likely go into its meeting next week with an uncomfortably strong dollar. I fully expect at least some rhetoric noting its strength. If jawboning does not reverse the pressure on the dollar (I do not expect that it can or will), I expect real action within the next meeting or two if the dollar remains stubbornly high.

Be careful out there!

Disclosure: I am long GLD, CAT.

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