Wednesday, March 12, 2008

U.S. Dollar : Where Is The Bottom?

The U.S. Dollar use to be a safe haven when ever economic storms were on the horizon. With the inflating of every possible asset bubble over the past decade, the Federal Reserve has now decided to continue cutting rates when there is in fact little bubbles worth inflating.

It is often said that "this time things are different", but human nature never changes. Cycles happen and while they might be derailed for periods of time by outside influences, they all eventually run their course. As the Federal Reserve continues to cut rates and flood the market with liquidity to keep this economy oiled, the effects of their action counter every stimulus they attempt to create. They can only cut rates to zero and they can only cut down all the trees and print dollars, but when this doesn't work, what will they attempt next. The rates they keep lowering now are not effecting mortgage rates and does not seem to help the people it is intended to help, if you believe Washington. As they cut rates the dollar continues to fall and this causes inflation to become the main culprit. In a few months time inflation will become the headline of the news cycle, and the Fed will make some statement like a light bulb just went on. The chart below shows an example of the increase in the price of oil as the U.S. Dollar declines. Supply and demand aside, the dollar, the Federal Reserve, is responsible for this climb.

U.S. Dollar vs. Light Sweet Crude

As this chart shows they are almost a mirror image. The good news is that the Federal Reserve can only cut rates so far, and as they approach this level, expectations will start to look out for them to raise rates because of inflation fears. The chart below shows the S&P 500 Index and where interest rates were back in the booming 1990's.

S&P 500 And Interest Rates
The dollar should begin to strengthen when the Fed can not cut rates anymore and decides to focus on inflation. When oil goes from $110 back to $85, it will be seen as a new boom for the economy. Then the focus will be back onto which economy in the global market is growing the quickest, and has the most potential for growth.

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