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US Dollar: Where to From Here?

As goes the dollar, so goes the economy.  Perhaps.  The next FOMC meeting is March 20 and 21.  It is almost a forgone conclusion that the Fed will cut rates, perhaps aggressively.  Meanwhile, the dollar is weak, and another rate cut will likely weaken it further. It currently takes $1.01 to buy one Canadian dollar (called the loonie) and that is the wholesale rate.  At a retail currency exchange you will pay about $1.09.  In 2002, it cost only about $0.65 to buy one loonie. 

So when in the past did the loonie exceed parity with the dollar? I'll give you some hints. The Everly Brothers had a big hit with "Bye Bye Love."  Cadillac came out with a new model that had gigantic tail fins, below.

Dollar Likely to Fall on Rate Cuts

   Bernanke just announced that "We stand ready to take substantive additional action as needed to support growth and to provide adequate insurance against downside risks."  The market responded with a +100 point move ion the DJIA.

   On the other side of the Atlantic, the Bank of England left rates unchanged at 5.5% (incredibly) citing a weak pound that has fallen 9% against the euro since August and "inflationary pressures from energy and food costs." The BOE has to balance the same conditions as the Fed: a slowing economy and rising inflation.  The full story can be found at the Guardian.   Also today, the ECB left interest rates unchanged at 4 percent.  Although the ECB's Governing Council discussed raising rates , but that the consensus was to keep them on hold.  However, Trichet, head of the ECB made it clear that the bank is in a rate hiking mode: "The Governing Council remains prepared to act pre-emptively so that second-round effects and upside risks to price stability over the medium term do not materialise. We are in a position of total alertness."  This will put further pressure on the dollar - the euro is up 1.4% against it today.  I am looking for the euro to move above $1.50 when the Fed cuts rates at the end of January.

What's in Store for the Dollar in 2008?

   New York Times recently had an article entitled: "Could It Be the Year of the Rising Dollar?"  The story is here.  The short answer is "No, probably not." The next Federal Reserve meeting is January 30 and 31.  Given the recent jobs report and the struggling economy, it is a foregone conclusion that the Fed will cut rates, and probably by 50 basis points. 

   Meanwhile, the ECB's Governing Council will meet in Frankfurt on Jan. 10.  It is widely expected that the ECB will keep its benchmark rate at 4 percent when it convenes.  This will move the dollar lower against the euro in the short term, likely breaking through the $1.50 level.  Inflation in the eurozone remains a problem.  In December it was 3.1 percent for consumer goods and producer costs were up 4.1 percent.  The target rate for inflation in the eurozone ios 2.0 percent. The money quote from ECB President Jean-Claude Trichet's January 5 meeting in Weisbaden was:  "The ECB's Governing Council stands ready to counter upside risks to price stability."  Translation: no near term rate cut and the possibility of increases.  The Bank of England is more likely to cut rates at its next meeting. The economy in Britain has been struggling with the many of the same credit issues as the US and there are mounting fears of a recession (although arguably, many of the problems were exported to Britain from the US). The results of the Bank of England meeting will be announced Thursday morning at 7 a.m.  The money quote from the minutes of the bank's prior meeting: "On balance, the Committee thought that the downside risks to the economy and inflation in the medium term from the deterioration in financial market conditions outweighed the potential upside risks to inflation from short-run cost pressures.  So while the pound may devalue wit the dollar in the short term, the euro is likely to go the other direction.

Inflation Subsides, but ECB likely to Raise Rates

Eurozone inflation reportedly dipped to 1.8 percent last month.  Inflation has been below the European Central Bank's (ECB) 2.0 percent target for the last eleven months.  Will the bank cut rates?  Probably not.  Analysts say the ECB will likely raise rates yet again to 4.25% in September. Since 2005, the rate has been lifted by a quarter point eight times. This begs the question: why would the central bank add liquidity to the market (as it has recently) and raise rates at the same time?

In the EU, inflation varies considerably between the various countries: Malta (-0.2%), France (1.2%), Ireland (2.7%), Bulgaria (5.5%) and Hungary (7.5%).  These varying rates are the reason the ECB is sometimes criticized for its "one size fits all" monetary policy.  But note that a rise in ECB rates and a much anticipated cut by the fed on September 19 would devalue the dollar further.