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U.S. Dollar Rally for Real?

Currencies / US Dollar Dec 18, 2009 - 06:19 PM GMT

By: Sy_Harding


Best Financial Markets Analysis ArticleIn this column in September, I wrote of how the U.S. dollar has been in a long bear market since 2001, while investors and traders were acting as if the dollar’s decline had just begun this year. Betting against the dollar had become the talk of the financial media, with “Sell the dollar, buy the Euro” the most popular advice from analysts.

With big profits having already been made by the smart money that had been shorting the dollar for several years, and public investors belatedly convinced the dollar’s total demise was imminent, I said “It’s more likely time to be watching for an upside reversal”.

I gave two reasons for that expectation.

In our technical analysis the dollar was oversold beneath its long-term 30-week moving average, to a degree that usually results in a rally at least back up to retest the overhead resistance at the moving average, even if the downtrend is to resume. That was a reason to expect at least a short-term rally.

My reason for believing the dollar was perhaps close to a more important bottom was that investor sentiment for the dollar had become extremely bearish. Investor sentiment is known as a ‘contrary’ indicator, in that investors are usually very bullish at market tops (any market), and very bearish at important market lows. And the dollar was (and still is) completely unloved, out-of-favor, sold-short very heavily, with positioning in strategies calling for a further decline in the dollar very popular.

Sure enough, in November the dollar quietly began to strengthen. It first managed to break out through the resistance at its short-term 30-day moving average, and has continued to rally since.

So is the rally for real?

It is now at an important juncture. Its rally of the last five weeks has it back up to its 30-week moving average, potential overhead resistance.

There have been two bear market rallies in the dollar, one in 2005, and another last year, when the dollar managed to break out above its 30-week m.a. The dollar gained 15% and 24% in those bear market rallies before its downtrend resumed.

Given other conditions at present, a similar move should be underway if the dollar can continue to rally enough to break out above its 30-week m.a. this time. And if this turns out to finally be the end of the dollar’s eight-year bear market, the upside could be substantial.

On the fundamentals there are a number of influences that could be bringing the dollar’s long slide to an end.

For instance, throughout the dollar’s serious decline, which began in 2001, each Administration has claimed it supports a strong dollar, but did nothing about its decline. That’s understandable, since a weak dollar helps the U.S. economy by making U.S. exports less expensive in foreign countries (and imports coming into the U.S. more expensive). And the U.S. economy has been in two recessions in the last nine years from which it had to undertake unusual stimulus efforts to extricate itself.

However, with the economy now showing enough signs of economic recovery that talk is of the Fed having to soon remove the punch bowl of easy money to prevent inflation, it may also finally be in a position to take steps to strengthen the long-sagging dollar.

It has reasons to do so. Global complaints about the dollar’s loss of value has had pressure mounting all year to replace the dollar in international trade with a basket of global currencies.
The decline in the dollar’s value has also raised the risk that foreign investments in U.S. dollar denominated assets will dry up, or even that dumping of those assets could begin.

So, there are reasons to believe the U.S. government will begin to actually support a strong dollar instead of just talking about it (and may have already begun to do so). That would provide another reason to believe the current short-term rally in the dollar can have legs, could even finally be the beginning of a new bull market for the dollar.

Yes, that does raise concerns for the stock market, since for quite some time the stock market has been moving opposite to the dollar, declining when the dollar rallied, and rising when the dollar declined. And the stock market has stalled and moved sideways since the dollar began to rally in November.

However, that does not necessarily have to continue.

Historically, the dollar has moved as often with the stock market as opposite to it. For example, the dollar was in a strong bull market in the 1990’s in lockstep with the stock market’s bull market, with the U.S. Dollar Index rising from a depressed 78 in 1992, to a high of 121 in 2001.

So we shall see..

Sy Harding is president of Asset Management Research Corp, publishers of the financial website, and the free daily market blog,

Disclaimer: The above is a matter of opinion provided for general information purposes only and is not intended as investment advice. Information and analysis above are derived from sources and utilising methods believed to be reliable, but we cannot accept responsibility for any losses you may incur as a result of this analysis. Individuals should consult with their personal financial advisors.

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