Has the U.S. Dollar Bottomed?

By: Bryan_Rich

For much of 2009, the dollar has been the Tiger Woods of global currencies. There has been a relentless snowball of negative sentiment. And for a period of time, seemingly everyday something new, bigger and more shocking about the buck was being circulated through the media.

As Tiger can attest, when it rains, it pours …

There was news that China was trimming its holdings of U.S. Treasury bonds because the weakening dollar posed a threat to the value of their reserves.

The dollar dropped to a 2009 low. And government bonds fell when worries over rising U.S. debt levels started circulating questions about the strength of our country’s AAA credit rating.

The dollar has been the Tiger Woods of global currencies.

Bernanke responded to dollar scrutiny with this statement following his speech in Jekyll Island:

“I think the issue at hand is whether or not the dollar will retain its value, and I think it will.”

That was not exactly a resounding vote of support.

Then the BRIC countries (Brazil, Russia, India and China) got together and lobbied for the replacement of the dollar as the world reserve currency.

Gold charged back to $1,000 and broke-out to new record highs as global investors looked to gold as a hedge against a falling dollar, and the potential inflationary policies the U.S. had undertaken.

And because of rock bottom interest rates in the U.S. and the falling trajectory of the dollar, it has even been used as a new funding currency for another carry trade.

Still, How Low Did the Dollar Really Go in 2009?

The sentiment has been brutally negative for the dollar. So much so that even on days when there was no real news, the media couldn’t resist running front page doom and gloom stories about the future path of the leading global currency.

But contrary to what many may think, the dollar didn’t reach record lows. In fact, at its lowest point this past November, the buck was still 5 percent above its lows from 2008.

Take a look at this chart of the dollar index …

Source: Bloomberg

As you can see, the dollar index surged 26 percent from the middle of 2008. Investors from around the world were running scared and found safety from the widespread economic crisis by plowing capital into the deepest, most liquid currency in the world — the U.S. dollar.

Subsequently, the dollar declined since March of this year, as fear abated and global investors gradually reversed the safe haven trade, putting capital back to work across the globe.

But even under the intense scrutiny of the past nine months, the dollar has managed only a gradual decline relative to its sharp rise of 2008.

And despite all of the doom and gloom stories over recent months, the weight of evidence is now working in the dollar’s favor!

It Looks Like the Dollar Is Breaking Out …

Americans love a comeback. And I suspect Tiger Woods will need to win at least a few golf tournaments to repair his iconic status in the golf world.

However, I don’t think the dollar will have as tough a time redeeming itself. I believe that it’ll only have to stage a sustained bounce for a couple of months to relieve the pressure valve from the dollar haters.

Already there has been a groundswell of positive news for the dollar that makes a comeback scenario look increasingly more likely …

It kicked off with the latest employment data: A downtick in the unemployment rate and a positive surprise showing far fewer new job losses. This started shifting the market’s focus toward the prospects that the Fed might start raising rates a little earlier than consensus expectations!

Then the recent retail sales report showed a much stronger number. That was a sign that the consumer might be coming back. Another data point that has encouraged market participants to consider improved growth and higher interest rate prospects in the U.S.

The dollar could be set for a comeback.

So we now have two developments on the economic recovery front that are positive for the dollar.

On the other side of the equation, global economic risk is soaring! And that’s good for the dollar as a safe haven currency.

The potential for a sovereign debt crisis has surged since Dubai notified its creditors late last month that it wouldn’t be making its next payment. Now it’s Greece that’s under the microscope regarding its ability to service large government debts. And a host of other European countries are looking increasingly riskier for similar reasons.

And finally, on Wednesday, the Fed announced that it would be closing its currency swap lines with foreign central banks by February 1, 2010.

When they opened these massive swap lines in late 2008, the goal was to alleviate the dollar liquidity crunch at banks around the world. However, in the process they increased the supply of dollars around the globe — a negative consequence for the value of the dollar. But now that these lines will be closed, it’s clearly a dollar-positive development.

So the market scrutiny is starting to shift away from the dollar. And there are plenty of ugly currencies out there that will likely take the spotlight.

Regards,

Bryan

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