US Dollar

Some analysts are surprised by the evident unwillingness of Central Bankers to intervene on behalf of the Dollar, especially considering how common such "rescue plans" are becoming in other corners of the financial markets. Over the last couple months, all of the momentum that was previously behind intervention has gradually evaporated, such that at the recent G8 Summit, currencies were hardly even discussed. This is somewhat ironic considering the Dollar has resumed its downward trend, and even touched an all-time low against the Euro. Treasury Secretary Henry Paulson and Fed Chief Ben Bernanke aren't willing to completely write off intervention, however. Both have commented explicitly that it is still being mooted as an option.

Without exception, every time there is a period of sustained volatility in forex markets, a flood of new forex accounts are opened as new traders try to capitalize on the action.  Also, without fail, a concerned journalist inevitably takes it upon himself to warn these would-be profiteers that trading forex is risky, as if that were not abundantly obvious. This past week is a perfect example, as the Dollar touched a record low against the Euro on the basis of credit concerns. One columnist pointed out the significant upside potential of purchasing a CD denominated in foreign currency, but also implored investors to hedge their exposure and limit leverage.

Who's familiar with the "song that never ends?" How about the credit crisis that never ends?

The narrative in forex markets had recently become so cut-and-dried, that investors may have forgotten that in the long-term, a variety of factors weigh on currencies. Last week, they were sternly reminded of this fact when tensions in the Middle East boiled over and sent the Dollar racing downwards. An Iranian missile launch sparked the initial uproar, but was quickly followed by unrelated violence in Turkey and Iraq. First, the price of oil skyrocketed, and then the Dollar fell, consistent with the inverse correlation which has been observed between the two commodities. It is unlikely that geopolitical tensions will supercede the macroeconomic situation; investors continue to monitor the credit crisis and interest rate differentials with vigilance.

In a bid designed to placate skittish investors, America's Federal Reserve Bank announced that it will extend the duration of its liquidity facilities at least through 2008 and possible into 2009. It is hoped that the continued enabling (which began several months ago) of certain Wall Street firms to borrow on especially favorable terms will prop up faltering credit markets. Given that both credit conditions and the economy at large continue to flounder, this move seems more symbolic than anything. Analysts are divided about whether this increased liquidity will serve as a complement or a substitute for a near-term interest rate hike. Futures prices had previously reflected a 65% chance that the Fed would hike rates in September, but the bet is now closer to even money.

At its most recent meeting, the Fed voted to hold rates steady at 2%. Only one week ago, 90% of investors (based on interest rate futures) had expected the Fed to lower rates.  What changed?

The looming possibility of forex intervention in response to the Dollar's continued weakness is causing an uproar in forex circles. Some analysts don't feel intervention is a real possibility because it is so inconsistent with the ideology espoused by the current US presidential administration. In a piece published in the AsiaTimes, however, one expert noted that the history of the Dollar is also a history of intervention. Even when the Dollar was still linked to the Gold Standard, the Fed intervened by buying or selling gold depending on the result it wanted to achieve.

Forex analysts reckon the two most powerful forces weighing on the Dollar are commodity prices and European prices, so-to-speak. With regard to commodity prices, it seems plausible that rising commodity prices have contributed to a weaker Dollar, as much as vice versa. Thus, when Saudi Arabia announced recently that it would increase oil production, the Dollar received a nice boost. Conversely, European prices, or inflation, are important for traders to monitor because they represent a proxy for the future of EU monetary policy. Specifically, Eurozone inflation just touched another high, at 3.7%, which analysts point out is now 1.7% higher than the ECB's stated comfort zone.

G8 finance ministers met last week to discuss the detrimental effects of rising (commodity) prices on the global economy. Oil prices and commodity prices have in some cases doubled over the last year, contributing  to a nasty surge in worldwide inflation rates. While the Dollar was not technically a topic of the discussion at these particular meetings, it was broached tangentially because of the perceived relationship between the weak Dollar and high commodity prices. Accordingly, Central Bank intervention on the Dollar's behalf could theoretically be justified on the basis of both mitigating inflation and facilitating global macroeconomic stability.

George Soros, one of the most well-respected investors who sits in the same echelon as Warren Buffet, just released his book on the current state of the world's financial markets. His conclusion is that a "super-bubble" is forming. Connecting to all of the major financial markets, namely property, commodities, and equities, Soros outlines how the expansion in credit that has unfolded over the last 30 years has caused an unsustainable run-up in the prices of most investable assets. Due to the resulting inflation, investors are now fleeing en masse from mainstream securities and parking their money in commodities, triggering a super-bubble therein.