The Dollar May Get Some Relief from Fed's Official Exit Strategy

By Dr. Duru written for One-Twenty

July 21, 2009

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The dollar has been stuck in a trading range for about two months as it hovers above December's lows.

U.S. Dollar
*Chart created using TeleChart:

I still expect those lows to break eventually, but in the meantime, the release of the Federal Reserve's official exit strategy from easy monetary policy may spark some kind of relief rally in the dollar. Several currencies are now "overbought" (based on daily stochastics) against the dollar - including the Pound, the Euro, the Canadian dollar, and the Aussie dollar - so a pullback in these currencies in the coming days or week appears likely.

Fed Chairman Ben Bernanke is trying to reassure us that money will remain easy long enough to take care of the current recession but not a dollar longer. Never mind whether all of the Fed's strategies will work (for example, some or many of the assets the Fed thinks it can shed from its balance sheet and sell into the market at will may prove to be worthless or otherwise unwanted and unloved) or whether the political climate will even allow the Fed to tighten if the economy so much as sneezes during a tightening phase. The near-term point is that the market will likely adjust its expectation for U.S. inflation and the on-going debasement of the dollar based on the talk alone. Going forward, traders and investors will look closely at Fed statements for hints as to when exit strategies may begin in earnest.

The dollar is oversold at the same time the stock market is extremely overbought. Renewed talks of exit strategies may provide a catalyst to take some steam out of the market...just as markets sold off after G8 finance ministers chatted openly about exit strategies at the end of June. Also note that the percentage of stocks trading above their 40-day moving averages (T2108) rose back above 70% on Monday, the threshold that typically marks an overbought market. Perhaps even more notable is that the percentage of stocks trading above their 200-day moving average (T2107) has reached an eye-popping 81%. This is the highest level yet during this rally and such levels were last seen in May, 2007. Buying pressure has quickly returned to the market after the recovery from the last oversold conditions. With Goldman Sachs issuing up a year-end price target of 1060 for the S&P 500 now that the market has already hit its previous year-end target of 940, my expectations for the June highs to hold for the summer and for a steep correction in the Fall are sure to get a good test. However, given that Goldman recognizes the risk of a double-dip recession, I must wonder just how far the market will push toward the new price target in advance of more clarity around these risks.

Be careful out there!

Full disclosure: long USD/CAD, short AUD/USD, long SSO puts. For other disclaimers click here.

DR. DURU®, 2009