How much further can the dollar plummet? That was the question the WSJ (subscription required) tried to answer in “Dollar’s Race to the Bottom:”
Even as the tired mantra of a U.S strong dollar policy was repeated by Treasury Secretary Timothy Geithner this week and Ben Bernanke on Wednesday, the greenback continued plumbing new depths. The ICE dollar index is at its lowest since 2008. This year the dollar has hit record lows against the yen, the Australian dollar, the Swiss franc and the Singapore dollar, J.P. Morgan notes. All the forces look negative. But investors should weigh the risks carefully.
Most obviously, the dollar is suffering from ultraloose U.S. monetary policy. The Federal Reserve continues to hold rates at zero and buy bonds. While the money printing is finally scheduled to end in June, the Fed still plans an extended period of low rates. Meanwhile, central banks elsewhere are firmly in rate-raising mode, including the European Central Bank, which seems determined to burnish its inflation-busting credentials. A big yield differential between the U.S. and Europe could open up.
There also is the risk of further dollar weakness if it starts to reflect fiscal concerns, as the euro did last year. Washington has shown little evidence of its ability to agree to a coherent plan to tame the runaway deficit.
The danger is chasing the dollar down this apparent one-way street. The biggest threat to the conventional wisdom is the potential for a dip in risk appetite. That might be sparked by the end of quantitative easing, or a more serious resurgence in the euro-zone debt crisis, particularly if it threatened Spain. A risk-off trade likely would cause a dollar spike on safe-haven flows and investors closing short-dollar bets.
But even that likely would be temporary. Even though Mr. Bernanke made clear he will act if inflation risks rise, soaring asset prices and the impact of higher commodities prices into headline inflation are likely to continue being ignored. While the bar for further money printing is getting higher, the message from Wednesday’s meeting was the Fed remains committed in its experiment of superaggressive monetary policy to reduce unemployment and pull the U.S. out of its economic mess.
There is no question that UUP is deeply entrenched in a down trend as the 2-year chart above (courtesy of YahooFinance) shows. While currencies tend to stay in prolonged trends for quite some time, a sudden turnaround is always a possibility.
That holds true, especially when viewing the economic landscape of Europe, which is anything but stable with several disasters lurking on the horizon. Debt defaults by Greece and Ireland, which are a real possibility, can turn this bearish dollar trend around in a hurry, as the flight to a safer alternative would be bearish for the euro and bullish for the dollar.
From my viewpoint, the only reason for the current euro strength is the call by the ECB for higher interest rates to combat inflation. Here is the U.S. the Fed has made it clear that lower interest rates are here to stay for the time being. This disparity in policies has benefitted the euro and pushed the dollar to its lowest levels since 2008.
Follow the trends and watch for an upside breakout, at which time UUP might present a buying opportunity again. Until then, it is stuck in bear market territory.
Disclosure: No holdings