Unless the current trends change it seems as if the U.S. dollar might have bottomed while U.S. stocks have failed in their latest rally attempt. At the center of the key developments, as usual, is the future of interest rates.
The dollar, against all odds, is starting to rise, with the U.S. Dollar index (USD, below) climbing above its 50-day moving average on 12-14, hitting its highest level since late October. To be sure, the potential for a longer term rally remains in question, given the resistance at the 80 level, as the chart shows.
Chart Courtesy of StockCharts.com
Still, it is important to note that when currencies reverse trends, the new trend tends to remain in place for a very long time. The current decline in the dollar has been in place since 2001, after 9/11, despite an occasional snap back rally.
Currencies usually respond to three factors, the strength of the underlying economy, interest rates, and the political climate of the country that it represents.
In the current enviroment, the U.S. economy is weakening, but by some accounts not as much as had been expected as a result of the subprime crisis. As a result, the potential for extremely low interest rates is in question, although it is not settled by any means. From a political standpoint, though, change is ahead, and that may be the key to the dollar's turnaround.
If the Democrats win, a possible scenario, it is almost a certainty that taxes will rise, something that may improve the U.S. budget deficit, as it did in the Clinton years. That would be dollar friendly, as it clearly was during the 90s, when the strong dollar camp was in the White House.
If the Republicans win, there is no way of telling what will happen, as none of the candidates from the GOP have any real track record for large scale economic tendencies. Sure, they talk about low taxes and the usual GOP free market stuff. But no one really knows what to expect.
Which of course leaves us with considering the future of interest rates. The Fed has been sending mixed messages about rates for some time, having lowered the Fed Funds and the Discount rate three times over the last several months to allay the liquidity problems caused by the subprime markets.
But, if you look at the subprime crisis more closely, although it started in the U.S., and U.S. firms and homeowners have been widely affected, the Europeans have been hit harder, with more marquee names in Europe faring worse than U.S. firms affected by the crisis.
It's the Libor rate that is out of control on a daily basis, not the Fed Funds rate. And it's the Euro that looks to have topped out, while the Dollar has bottomed.
And while Europe and the U.S. are getting slammed, Asia, outside of Japan, seems largely unscathed, at least by the subprime crisis in the U.S. with the problem possibly facing the so called Tiger nations and China being runaway real estate speculation.
Yet, even there, according to Marketwatch.com, there are some signs of trouble starting to surface with "Joseph Yam, the Hong Kong Monetary Authority chief known for his distinctive silver mop of hair as well as being the world's highest paid central banker, raised a red flag that local banks will not escape unscathed." According to the report, his remarks led to heavy selling in the shares of small Hong Kong banks.
Meanwhile, "Bank of China Hong Kong is estimated to have HK$10 billon ($1.28 billion) exposure to subprime-related investments but is better protected by its larger size."
Conclusion
Europe is in trouble, and so is the U.S., as the repercussions of the subprime crisis continue to play out.
China and Asia, perhaps outside of Japan, are supposedly out of the woods, or may experience less trouble than the U.S. and Europe, according to the conventional wisdom.
Yet, money from somewhere is moving into the U.S. dollar, some six years after a massive exodus, which coincided with the post 9/11 recession in the U.S.
It's hard to explain where that money is coming from. Yet, in 2001, much of it went to the Tiger economies looking for growth.
Maybe, just maybe, that money is starting to come back to the U.S., as growth seems to be a less than adequate substitute for something different. That something different, though, is hard to define right now, but in and of itself, its purported existence may speak loudly about what may yet be lurking somewhere out there, outside of the U.S.
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