The U.S. Dollar Going Forward ~ market folly

Wednesday, August 13, 2008

The U.S. Dollar Going Forward

Courtesy of the Federal Reserve Board we see an interesting chart depicting the decline of the US Dollar as well as its impact on the price of crude oil. Seeing the price of crude oil charted in other currencies really puts into perspective just how much the weak dollar has helped commodities. Sure, much of the commodity story has been fundamentally driven. But, the dollar has undoubtedly played a role in the rise of commodities.

The question I pose now is: Where is the Dollar heading longer term? Shorting the US Dollar became a crowded trade very quickly. And, with the right set of catalysts (as we've seen recently), the Dollar can indeed rally. But, is this rally really a turn-around, or rather just a counter-trend rally. The fed seems poised to raise rates in their coming meetings. The ECB seems concerned with growth rather than inflation currently. Both point to a bullish future for the Dollar. But, I still have to believe that this is merely a counter-trend rally within a longer term downtrend.

Much damage has been done to the dollar over the years. Just look at the chart, it speaks volumes. From 2002 until present, the dollar has really done nothing but decline in value. Sure, there are some rallies here and there. But, they are very short lived. It rallies up to the downward sloping trendline only to decline yet again. The only time where the dollar really held its own was during the years 2005 and 2006. During these years the dollar traded sideways for the most part. And, I think we are setting up for the Dollar to trade sideways for a longer period of time. While we cannot predict the future, we do know that the Fed can only do so much with their rate increases. What happens after they are done with their cycle? We'll obviously have to address this as the currency market continues to unfold. While I think the dollar can (and probably will) see a substantial rally in the coming months, I still believe it is just a reversion to the mean within the context of the broader picture. After the rally secedes, we could very well see a period of stagnation.