Wednesday, October 27, 2010

Dollar delerium?

Last week the Chinese announced that they were going to raise interest rates.  Recently the Fed has been making a case for more quantitative easing (and therefore no rise in interest rates in the US), and the ECB hasn't been making a case for any more quantitative easing there, but guess what, the dollar decides to go up!  This, of course, goes completely against what you'd expect from economics, where higher interest rates usually cause money flows out of other currencies into the higher return currency.   Below we have how many dollars the euro has bought since it was launched in 1999. 


But what is interesting in the recent dollar movements is the fact that the dollar has seemed to be the focus of the markets, particularly because of its impact on monetary policy and commodity prices.  Higher US$ commodity prices are supported by a falling dollar as when converted into foreign currency the price is roughly constant, so the recent fall in commodity prices now implies a higher dollar.  But are commodity prices really headed lower when demand is becoming extremely buoyant in the rest of the world outside of the US?  

My own view is that the current US$ strengthening is only temporary - what with QE2, however you cut it, it implies a weaker, not a stronger US$.  The only caveat I would make though is that if I am wrong on US growth and we see stronger exports as US manufacturers take advantage of the lower US$ to boost their market presence in emerging economies, plus the emergence of another crisis in Europe (perhaps surrounding the Portuguese who cannot seem to agree on their budget - see http://www.ft.com/cms/s/0/b8bedc0e-e1d5-11df-b71e-00144feabdc0.html) then this might put a floor under the US$, and might even promote some appreciation.

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