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First with Financial Comment from Arabia

Dollar likely to strengthen in the short term, then weaken

with 3 comments

It only seems yesterday that every pundit was down on the dollar. Yet the greenback has bounced off $1.50 to the euro and has been flirting with $1.38 and $1.59 to the pound sterling. The dollar may now surprise on the upside.

Why? Partly because so much negative news was heaped on the dollar that the market forgot that other economies also have problems too. Look at Greek debt or Spanish unemployment or debt-to-GDP levels in the UK.

Wall Street correction

Then there is the start of the unravelling of the rally on Wall Street since the New Year. US stocks lost five per cent in value last month, and as stocks are sold off then the US currency starts to rise in value. For when you sell a US stock you get dollars in exchange and that increases the demand for dollars and pushes up the value of the greenback.

This is the so-called flight to safety impact of a stock market correction. Now given that US markets look overvalued after the very long rally from last March then the a bigger than average correction might be expected, and thus a bigger than average rally in the US dollar.

The next question is how long this dollar strength is likely to last. For as the dollar rallies so will the US bond market in parallel, with investors willing to accept very, very low interest rates in return for a risk-free asset class, or at least that is the market perception of this risk.

Meet Mr.Bond

The reality could be something rather different. For the big danger is a collapse in the bond market after this rally is done. Basically the money printing of the Federal Reserve means that inflation, at some point in the future, is baked in the cake – so you do not want to be holding currency when it happens, and especially not bonds whose value will fall as interest rates rise to compensate savers for inflation.

So there could be a rush to another safe haven, say gold and silver or commodities in general, if investors still do not like the look of equities after a big correction and are fearful about the impact of inflation on cash. Thus a devaluation of dollar purchasing power – nothing new over the past century – will eventually follow whatever the short term prospects for a dollar rally.

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Written by Peter Cooper

February 1, 2010 at 12:38 pm

3 Responses

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  1. Peter:

    The Euro Problem:
    The financial crisis in Europe (and in the Euro, by default) is getting much worse with each passing day. Leading the “charade” is Greece, whose debt to GDP will soon approach 135%. That is simply unbelievable.

    Following closely behind Greece is Spain, then Italy, Ireland, and Portugal.

    Money is fleeing the Euro rapidly, and moving to the USD, even though the USD is also in deep trouble; investors realize that, as ugly as the USD is, the Euro is even more ugly.

    The Most Likely Scenario to Unfold:
    So yeah, look for the Euro to weaken substantially, and look for the USD to rally in the short term. The only currency that will continue to remain sound is gold (and silver), because it requires no “counter-party” or guarantee. A gold coin’s worth is intrinsic in itself. We can’t say that about any other type of paper currency in the world.

    P.S. for your readers: here’s an interesting commentary on the Greek problems, by Ambrose Evans Pritchard, whose commentaries are always spot-on!
    http://www.telegraph.co.uk/finance/comment/7119986/Should-Germany-bail-o

    obewon

    February 1, 2010 at 9:45 pm

  2. I also expect the US dollar to strengthen short term. After Chinese New Years it will continue to weaken until they raise interest rates some where between April and June.

    Andy

    February 1, 2010 at 9:12 pm

  3. Wishful thinking I reckon, specially given the new stimulus packages coming to support the war on unemployment.

    As soon as the new packs are confirmed in senate its back to happy days again!

    nigel

    February 1, 2010 at 2:18 pm


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