US dollar defensive but still trending toward 1.4328 against the Euro

Foreign Currency Exchange Outlook : The US dollar is on the defensive but still trending toward the spike low last December at 1.4328. Maybe we will get a corrective move this time and we certainly want to go into the long US holiday weekend without a position either way but the dollar rally is a trend, and we cling to trendedness. A trend tends to say in place until something big comes along to shake it out of its tracks. We do see two potential shakers—oil and the ECB raising rates. However, the robustness of the US economy is a possible strong offset. Is it strong enough to weather a serious oil price rise? Probably not, but again, oil is on a down trend that may have lasting power, too. The best we can hope for is a shake-out in both currencies and oil that leaves us at lower levels by the time Gustav exits the scene, say late next week, although true corrections can last longer than that.

Market observers make two points. The first is that many market players have not yet bought into the strong dollar scenario, leaving plenty of room to go. A 50% retracement of the euro’s rise from Oct ’06 at 1.2490 to the high of 1.6038 in July would take the euro to 1.4268. We like this number. It’s near the end-2007 low and it’s more in line with purchasing power parity. Nobody would argue that the euro exchange rate is not horribly overvalued at current levels.

The problem is the principle of currency markets that the currency with the rising interest rate/yield is the currency that benefits from global investment flows, as long as the rising yield is higher than inflation and/or expected inflation. We have a negative real return in the US today and that’s a serious drawback. Can it be fixed with hawkish rhetoric from Fed officials? Yes. All we need is additional comments from the Fed and falling oil to get the dollar back on its trend.

This is not an improbable story.

In sum, it’s too soon to bet against the dollar.

Bye For Now

Barbara Rockefeller

best exchange rates for Dollars - contact IMS Foreign Exchange