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The State of the US Dollar


The US dollar has been in a rollercoaster ride since the beginning of December 2010. A proxy for the reserve currency, the $USDX, has oscillated between the 79 and 81.61 levels.

Every time the index approaches one side of the range, either the bulls or the bears come out with their funky end-of-the-world stories. This time is no different as the pair trades at the 79 handle.

While I’ve been bullish on the US dollar, it appears to me that things are looking quite bearish for the American currency. It has nothing to do with the pair being at the 79 level but rather to how the currency has traded against all the majors in the past few months.

Recently, there has been this notion that the Greenback was gaining on good old US economic data and news. However, when you study the price action and the market dynamics, it does not look to be the case.

First, the fact is that the US Dollar is generally weak. It’s near all time lows against the Japanese Yen, Swiss Franc, Australian dollar, and the Canadian dollar. Of the majors, only the Euro and the Pound have been lagging against the US dollar, with the Euro being hurt by severe sovereign debt problems.

Thus, it’s hard to say that the USD is doing well when it’s doing poorly against every major currency except the one that’s been stepped on by everyone. The ICE US Dollar Index is deceiving and shows strength because the Euro makes up 57% of the index.

In regard to the belief that the US dollar has been bid up based on good economic data, especially against the Euro ($EURUSD),  I think  there is a missing piece to the puzzle. The true phrase to me seems to be that “the market was bidding the US dollar on good US data, given that the European situation was deteriorating “. A proxy for this European phenomenon could be credit default swaps for the PIIGS.

As CDS spreads for the PIIGs narrowed last week after the Portuguese and Spanish auctions, the EURUSD went through the roof and the USD lost significant ground against the single currency. One of the only places where the USD seemed to have an upper hand was put at risk.

Personally, I don’t see the sovereign problem going away any time soon. Greece has been a problem for one year already and it was only the start. And it could be that a long and painful crisis in Europe keeps the US dollar up for years.

Notwithstanding, my question for this post becomes the following: If the European situation is fixed, will the US dollar be in trouble? Or will innovation, US outperformance, and interest in US assets become a catalyst for a stable US dollar?

I wonder.

The information in this blog post represents my own opinions and does not contain a recommendation for any particular security or investment. I or my affiliates may hold positions or other interests in securities mentioned in the Blog, please see my Disclaimer page for my full disclaimer.

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