If you think Fed Chairman Ben Bernanke is drawing a line in the sand with inflation and is therefore unlikely to cut interest rates much more, then the US dollar’s misery is probably over. If not, then you don’t know what misery is.
Bernanke’s emphasis on inflation in the FOMC’s March monetary policy statement last week and policymakers’ decision to cut the federal funds rate three-quarters of a point rather than a full point was seen as directly supportive of the dollar in some quarters.
There’s little if any doubt in the mind of long-time Fed watcher David Jones, president of DMJ Advisors.
“For all intents and purposes, the Fed is finished cutting rates," says Jones, who says the central bank won’t go below 2.00 percent.
Jones says the “perfect way [to support the dollar] is to let the market think you're going to cut a full point and cut 75 basis points.” That's exactly what the central bank did when it only reduced the federal funds rate to 2.25 percent, rather than the 2.00 percent the market expected, he pointed out.
So with the Fed's help, the dollar is out of the gutter? Not everyone thinks so.
Boris Schlossberg, senior currency strategist at Dailyfx.com, says the dollar decline, which was beginning to appear un-orderly to some, is in something of a pause mode.
Sure, he says, it could rebound against the euro to the 1.50 level, after sinking as low as 1.59 around the time of the Fed meeting.
But Schlossberg and his company remain “serious dollar bears” long term because the Fed will take rates to 1.00 percent before it is done with its easing. “It is a slow-motion car wreck,” he adds, explaining that the housing problem will take awhile to unwind and correct.
A Long Way Down
Interest rate differentials – and a healthy share of speculation – have taken the US currency down to levels few imagined last fall, when the Fed started easing policy as the credit crunch emerged.
Since then the dollar has touched parity with the Canadian currency for the first time in four decades, reached two-to-one versus the British Pound for the first time in years, fallen through the psychologically important 100-yen level against the Japanese currency and touched record low after record low against the Euro, against which it has lost half its value in the past six years.
That deprecation – some might argue devaluation – has had greater ramifications than wounded national pride, credibility reservations about Bernanke and the Fed, or the dollar’s near century-old role as the world’s reserve currency.
It has helped fuel a boom in commodities prices, from crude oil to gold to copper to wheat, as well as provoke worries about stagflation for the first time in two decades ... negatives far outweighing any boom in US exports.
William Silber, an author and professor at NYU’s Stern School of Business, is among those who think concern about the dollar is over-done and short-sighted.
"I think the dollar is here because we have low interest rates and fears of a recession," says Silber, whose latest book is "When Washington Shut Down Wall Street". "Right now, the dollar is of secondary concern to the Fed."
The Argument for (and Against) Serious Dollar Appreciation
Which Way To Go?
Jones says it is possible for the currency to appreciate 15 percent to 20 percent in the next year or so as “people look at the dollar in a more positive way.”
Jones expects a scenario where “interest rate fundamentals turn.” Growth will slow drastically in Europe and the European Central Bank will cut rates as the United States emerges from its recession and starts raising rates.
But Maria Fiorini Ramirez, president of the economic consulting firm MFR, doesn’t subscribe to that.
She expects the dollar to be a “little lower’ against the euro in a year’s time, adding that it has “more of a chance appreciating against the yen.”
She says the Fed is “stuck between a rock and a hard place” on interest rates and inflation and, by association, the dollar.
In recent decades, the dollar’s demise has been greatly exaggerated. The last dollar slump came in 1994-1995. In early 1995, the US currency fell below 80 yen amid cries about the hazards of the twin deficits and a sea of dollars. Shortly thereafter, the dollar began a robust rebound for years, setting a record high against the newly arrived euro in 2000 and 2001.
What’s different today? In a word, the Internet, says Schlossberg. The emergence the Internet in the US brought enormous productivity gains and capital flows in the 1990s and up to the tech bust. And that attracted investment which, in turn, pumped up the dollar.
Today, the Internet is old hat. And today, there's no big new thing.
Ramirez and others add that the dollar is undergoing a fundamental reevaluation.
“I think the desire by big holders to diversify out of dollars is still there,” says Ramirez, citing a force that began in 2001. “Commodity exporting countries that have a lot of reserves are shifting those assets.”
Ramirez and Schlossberg cite oil producing Persian Gulf states as prime examples. China, Japan and Korea are also factors in this form of capital flow.
As the theory goes, the U.S. is in the early stages of losing its status as the world’s reserve currency, a process that some say started in 2001 after the 9/11 attacks.
Silber and others are skeptical, but admit that unlike the 1990s and the 1970s – when the Fed let inflation get out of control and the dollar suffered greatly – there is an alternative in the marketplace now in the form of the euro.
But even that doesn’t preclude a dollar rebound, never mind rally -- not that Silber is predicting one.
"The demise of the dollar as the international currency doesn't happen overnight," says Silber.