Is the Dollar back for good?

I bet this was the question uppermost in people's mind given the way global markets have been reacting lately. The week gone by being a case in point. Strength in the US Dollar saw a tumultous ride across markets, with the Euro plummeting the most in 6 years and weakness across the board in commodities. A special mention needs to made of commodities since it was the rally in this asset class which has stoked inflationary pressures globally and forced central banks to embark on a tightening spree.

Coming back to the question is the greenback going to see a sustained rally? Well, the present news flow seems to suggest Dollar strength in the near term, though its unlikely the rally will sustain over the medium term. The rationale behind this is the US is grappling with an economic slowdown amidst high inflationary pressures. The Federal Reserve which seems to be doing a tight rope walk at the moment, resisting pressures to raise interest rates. A few other signs do look ominous. The US labor market seems to be weakening, the credit crisis is thought to be only half way through, though losses suffered by institutions are likely to diminish here on. The housing market remains an area of concern. A statement from the CEO of one of the banks to emerge relatively unscathed from the credit crisis, JP Morgan Chase mentioned the outlook for prime loans, given to people with a good credit record was "terrible". A spread of the crisis to prime loans could have disastrous consequences for the US economy already reeling from losses at Fannie Mae and Freddie Mac, institutions which own or have guaranteed about $5 trillion in mortgages.

Another crucial factor for the Dollar strength has been expectations for weaker growth in the Euro zone. Economic data from the Euro zone clearly suggested an imminent economic slowdown, the markets seemed to ignore what was always apparent. It needed a statement from the ECB Chairman Jean Claude Trichet to see market participants hitting the eject button, and the Euro getting slammed subsequently. Can a similar thing happen with the US Dollar? The release of economic data will be the best gauge for this.

The present spell of weakness in commodities is being viewed as signs of a top being put in place for several commodities most notably Crude oil. It isnt an exaggeration at all to say, it is Crude oil which is driving international markets. I view the present weakness as a "correction" in a rally which has seen prices rising from $ 50 to $ 148 in less than two years. A move to $ 100 seems likely, though it is better to watch the markets closely than get carried away in the din surrounding falling crude prices.

To sum it up, the foreign exchange markets seem to have factored in most of the negatives for the US economy while the re alignment towards lower growth in the Euro zone has well and truly been set in motion. However the equation could change once again should something unforeseen by the market happen, like a rate cut from the FOMC. Will such a scenario materialise? I prefer to wait for the situation to fan out, as i watch what looks like a sea of red on the Reuters terminal!!