The Fed Will Likely Put An End to the Dollar's Relief Rally

By Dr. Duru written for One-Twenty

Aug 11, 2009

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As the dollar finally broke its December lows last week, I speculated that "...a strong US dollar relief rally in the coming week or so still seems likely given the synchronous multi-month highs being made by so many currencies against the dollar." Sure enough, over the past three days, the dollar has experienced a rapid bounce just about as sharp as the move down that took the dollar beneath the December lows. It seems that Friday's less-bad-than-expected jobs report ignited the relief bounce as the Fed funds futures produced higher odds of a slight uptick in interest rates by December. The stock market also responded with a sharp one-day celebration. How quickly sentiment can change: it was just a month ago when a poor jobs report produced all types of bellyaching and even some calls for yet more stimulus to the economy. The Republicans were crying foul that the Obama administration's policies are doing nothing for the economy. And now this month, Obama got his chance to join other world leaders in announcing we now have tentative signs that the beginning of the end of the recession has arrived. It truly is amazing to observe the stir that a "lagging indicator" can cause.

Anyway, When it comes to tomorrow's interest announcement by the Federal Reserve, I am betting that Ben and crew will be more closely referencing last month's poor showing. The Federal Reserve will also duly note that unemployment remains extremely high despite all the excitement over the current downtick in the unemployment rate from 9.4% to 9.2%. Finally, the Fed's forecast for high rates of unemployment sustained through 2010 will remain untouched. All this means that the Fed is not likely to provide any signs of imminent rate hikes (also see "Fed not ready to use other R-word: Recovery" for a similar point). The Fed's continued dovish stance should put an immediate end to the dollar's current relief rally if it has not already ended by the release of the actual statement.

As always, there are wildcards. The biggest wildcard that currently intrigues me is the Bank of England's decision last week to increase its quantitative easing program by adding another 50 billion pounds to the pot. This action stands in stark contrast to the more positive tones heard from The Reserve Bank of Australia and The Bank of Canada where recovery has become the main topic. Both Australia and Canada indicated general acceptance of the recent strength in their currencies. I suspect that the British have chosen to increase their money-printing partly in an effort to stall or even halt the rise of the Pound against the dollar (the Pound sold off quickly against the dollar on the Bank of England's announcement although it bounced back quickly against the Yen for a day). Since the Pound is part of the currency basket that makes up the dollar index, weakness in the Pound could slow the overall decline in the dollar.

Finally, if the stock market pulls back sharply in the Fall as I still expect, the dollar could once again serve as a (temporary) safe haven for risk averse investors. Be careful out there!

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

DR. DURU®, 2009