Has the Dollar turned?

The Macro Trader’s view: After a long bear cycle, the Dollar has spent the last 5 months, March – July, in a well-defined range. The pause in the Dollar’s sell-off was originally attributed to signs the US economy was over the worst of the credit crunch induced economic slowdown, indeed that view germinated from the Fed/J P Morgan rescue of Bear Sterns back in March 08. But with growth in the Euro zone continuing to hold up and inflationary pressures continuing to build, many analyst; ourselves included, judged the Dollar was merely correcting, and would resume its slide as the ECB’S hawkish rhetoric translated into higher interest rates; so far resulting in one hike which may prove to be their last. In the event, the US economy began producing mixed data, but with oil prices seemingly on a one way ticket to US$150.00 a barrel, the Fed joined the chorus of Central Banks that were becoming increasingly alarmed by energy induced inflation. So even when the positive impact of the US Governments tax rebate, had clearly begun to wane, the Dollar found support and remained within its range on growing fears of higher US interest rates. Now the situation has evolved further:

1. The US economy remains vulnerable to serious downside risks, even though inflation continues to vex the Fed
2. Euro zone growth is clearly weakening, with German Q2 GDP expected to have shrunk by 1.0%, but inflation remains stubborn
3. Japan has recently announced it is probably in recession
4. Once the Chinese Olympics are over, China too may see growth slow.

So while conditions in the US when taken on their own are arguably not terribly Dollar supportive, as evidenced by the Feds recent policy statement which explained why policy makers were leaving interest rates unchanged even though they saw inflation as a heightened risk, conditions globally have deteriorated and look like getting worse. Given this back drop Gold might have done better, as no one single currency shines on its own merits, but oil and other commodity prices are in the middle of a significant correction, which if extended will alleviate much of the current inflationary pressure, so traders are by passing gold and looking again at the major currencies. Once again the Dollar is the focus of their attention, as the World’s largest economy, and the first economy to begin slowing, traders’ reason that the US may well be the first to ultimately recover, even though timing on that event remains opaque. So the Dollar is now being used as a bench mark by which to measure the relative strength/weakness of the other leading economies relative to the US, and it looks to have at least topped out and may already be about to begin a new bull run. However, in-spite of the price action of the last few days, a Dollar rally may too prove taxing; the US economy continues to shed labour, and the rate of job loss seems to be accelerating as evidenced by yesterday’s jobless claims report. Moreover, US Banks and financial institutions continue to struggle and are still reporting losses and or significant write downs which will further curtail their lending activities and weigh on the economy’s ability to recover. In short, the Dollar seems poised for a significant recovery, but we judge it may prove a torturous path as the credit crunch is far from over and loop back effects may yet come into play and induce yet greater US economic weakness. Mark Sturdy John Lewis Seven Days Ahead [For the complete and illustrated version of this and future Updates be sure to sign up at www.sevendaysahead.com]