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Dollar dissonance

I must admit that I have been bewitched, bothered and bewildered by the dissonant messages being sent by the U.S. dollar.

The dollar has declined roughly 7 percent in the last nine months, but without a good fundamental reason behind the drop. The dollar index topped out at about 85 last July, falling to 79 at the end of last week. It's hardly a crash, but it is very much worth watching.

In the context of all of the events taking place in the world, the dollar should be getting stronger, not weaker, against most of the world's major currencies.

Andrew Paterson | Photographer's Choice RF | Getty Images

With that as background, I ticked off a mental check list that included the typical reasons a currency falls in value, asking myself whether the checklist was applicable to the dollar's recent descent:

Weak economic data? Maybe, but not really. There has been weather-related softness in the data, but the labor markets are improving and we are likely to see more "green shoots" in second- quarter economic numbers here at home.

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Easier monetary policy? Federal Reserve policy is still very easy, but quantitative easing is being reined in, leaving U.S. monetary policy a bit "tighter" than that of most other central banks, save for the Bank of England.

Rising domestic inflation? Nope.

Ballooning budget and trade deficits? They are all declining faster than anticipated, reducing the need to borrow money from abroad and reducing the risk of a fiscal crisis in the U.S.

Falling U.S. asset prices? Yes, but that typically prompts a flight to quality in the U.S. dollar, as we saw from 2008 to 2009, and during other major market declines of recent vintage.

Mass selling of U.S. assets by overseas investors? Possibly. However, that phenomenon would typically also be accompanied by rising interest rates, as U.S. Treasury holders dumped bonds, prompting a decline in bond prices and an accompanying jump in yields. Even if Russian and Chinese investors are reducing their bond holdings, and we're certainly not sure the Chinese are doing that, it's not showing up in the bond market, so it's a dubious explanation, at best.

So, as I ran through the list, nothing stood to me out as a good, or even typical, reason that would explain the dollar's persistent weakness. That led me to a few other possibilities: It may be geopolitical risk or even the risk of recession.

Geopolitical risk is a clear and present danger, as we have seen for months now, not just between Russia and Ukraine, but also within Turkey, Thailand, Venezuela and South Africa. There is also increasing tension between China and Japan over territorial issues in the South China Sea, something that has foreign policy experts concerned that it could lead to a military "mistake" between Asia's largest superpowers. However, In the event of a shooting war between Moscow and Kiev, or Beijing and Tokyo, the dollar, gold, oil, and U.S. Treasury bonds, would be safe-haven beneficiaries of such ominous, and dangerous, developments.

The dollar's weakness would be likely if, and only if, the U.S. were severely harmed by a geopolitical risk taking place overseas.

Then, there is the possibility of recession. When the dollar, U.S. interest rates and U.S. stocks fall in tandem, it could be a yellow — if not red — flag that implies U.S. economic growth has not JUST been hampered by the worst winter weather we have seen in years, but by something far more fundamental and threatening.

Assuming there is not an imminent recession, or major market catastrophe on the horizon (and recall that I am calling for a 10- to 20-percent correction in U.S. stocks, but not a "crash"), a sharp dollar rebound is possible in the weeks and months ahead.

Easier money in Europe and Japan, or an escalation of violence between Russia and Ukraine, some of which we saw over the weekend, could be the catalysts for just such a move upward in the U.S. dollar.

ECB President, Mario Draghi, said over the weekend, that persistent strength in the euro could prompt the ECB to launch a negative interest-rate policy and quantitative easing! A recent meeting between Japan's Prime Minister, Shinzo Abe, and the Bank of Japan may also produce easier monetary policy in Tokyo, both of which could suggest that the dollar is undervalued against the yen and euro.

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Rather noteworthy is the fact that long-term interest rates, around the world, are falling toward U.S. levels, narrowing the differential between U.S. 10-year bond yields and other sovereign yields, from Germany (below that of the U.S.), to Greece, which has narrowed the rate gap considerably, despite its well-known economic and fiscal troubles.

Everywhere you look in Europe, for example, rates are falling, and yet, the euro is rallying.

At the moment, I am ready to bet that the dollar is ready to run on the upside. It will be a small bet to start, but could build as various scenarios begin to materialize.

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Commentary by Ron Insana, a CNBC and MSNBC contributor and the author of four books on Wall Street. He also delivers a daily podcast, "Insana Insights," and a long-form weekly version, both available on iTunes and at roninsana.com. Follow him on Twitter @rinsana.

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