Dollar Showing Signs of Life

The last few months have certainly left currency traders scratching their heads. And the dollar’s path of consolidation, after touching an all-time low on March 17, is offering up far more questions than answers.

But as I watch the dollar move higher, I like to think it really is strengthening. After all, it would be refreshing to see an extended rally that challenges the greenback’s long-term bear market. And maybe I’m not alone on this thought …

Verbal Intervention:
Bush, Paulson and Bernanke
All Weighing in on the Dollar

Earlier this week, President Bush got his two cents in about the need for a stronger dollar. Granted, these comments have little clout since they simply mirror Treasury Secretary Hank Paulson’s agenda for a stronger dollar — an agenda that has mostly been backed by empty words rather than substantive action.

Paulson, however, was just over in the Middle East doing his part in securing the current dollar pegs among Saudi Arabia, the United Arab Emirates and Qatar. The potential for de-pegging among these countries has been a talking point for dollar bears over the last year or two. The very fact that Hank is making some effort to prevent the bearish possibility of de-pegging is somewhat reassuring.

The Treasury Secretary is also warming up to the potential for dollar intervention. While actual intervention is a lot easier said than done, simply talking about it may suffice.

Perhaps most important to the dollar’s battle over the last two weeks is the surprisingly strong tone coming from Federal Reserve Chairman Ben Bernanke. Two weeks ago he sent the dollar soaring with inflation comments that aimed directly at the consequences of a weak dollar.

It’s rare for a central banker to discuss foreign exchange rates at all. But Big Ben went as far as labeling a weak dollar as a major negative for the U.S.

President George W. Bush, Federal Reserve Chairman Ben Bernanke, and Treasury Secretary Hank Paulson have ratcheted up the volume and tone of their inflation-fighting rhetoric in recent weeks.

Talk about a change of heart! And Bernanke didn’t stop there …

He came out firing again this past Tuesday. His late-day comments capped a strong dollar recovery and opened up the door for follow-through strength. Bernanke stated simply, as highlighted in many news headlines in the wake of his remarks, that he and his fellow policy makers will “strongly resist” a surge in inflation expectations.

With Bernanke’s comments in mind, I believe it’s becoming increasingly clear where the Fed stands. Despite a struggling economy, and in the face of rapidly rising prices, it’s a good bet that the Fed Funds rate won’t be going lower than the current 2% any time soon. Stabilized interest rates would lend support to the greenback.

There are other reasons to remain hopeful …

First, the yields on 10-year Treasuries jumped to the highest level all year.

How is that relevant to the dollar? Well, rising Treasury yields suggest that investors are expecting inflation to remain a problem down the road. And that concern could inspire an eventual Fed Funds rate hike.

Second, the dollar is showing signs of life. And not just the typical dead-cat bounce smack in the middle of a downtrend. This consolidation period has been surprisingly refreshing for the dollar bull in me.

In fact …

It’s Looking More and More Like the Buck Is Working Hard to Put in a Bottom …

A lot has happened in the last two weeks of trading. But pushing aside the aforementioned political and central bank rhetoric, I’d like to look only at price action.

After a solid rally to finish up the month of May, the dollar hit the deck hard a week ago. What’s important to note is that those losses also marked a major failure after testing recent highs. Normally that’s a sign of weakness and begets further losses.

But the dollar didn’t give in, as you can see from my chart. Instead, it bounced back on Monday and Tuesday, more than erasing the disappointment of the two prior sessions. And then after a weak day of trading on Wednesday, the buck pushed to new highs.

Certainly this isn’t the type of rebound strength we’re accustomed to seeing with the buck!

Then again, I also noticed something not so encouraging: A bearish flag pattern that would imply an eventual breakdown to at least test its all-time lows is still in play. Take a look at this chart and you’ll see what I mean …

As I see it, one of two things could come from this:

Scenario #1: The dollar breaks convincingly out of the current period of consolidation, igniting a fresh wave of dollar-positive sentiment that invigorates the bulls and leaves the bears worrying that a legitimate bottom is in.

Or …

Scenario #2: The dollar belly-flops, igniting a fresh wave of dollar-negative sentiment that reinvigorates the bears and leaves bulls fearing that a legitimate bottom is not in.

Based on how the week finished up, I think scenario #1 is the more likely one right now.

Best wishes,

Jack

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