With more rough economic data hitting Wall Street again Wednesday (November 26), many analysts are beginning to speculate that the… … dollar may once again be headed for trouble.

The greenback has been strong against European currencies and other world currencies in recent months, thanks largely to falling oil prices. However, the reality of the current economic environment and a weak US economy means that the US currency is going to be hard-pressed to maintain its current values.

The dollar was weak for much of 2008 but experienced a sharp reversal against leading world currencies like the Euro and Pound beginning in mid-July at the point of the oil and gas price peak. The slide in oil helped propel a stronger dollar versus its European counterparts. The dollar was also helped relative to some other world currencies based on the realization that US economic challenges were spreading to other parts of the world.

One Euro currently nets just over $1.29 while a Pound is worth $1.5367. These are both still relatively strong positions for the dollar compared to where it was several months ago. The Euro peaked at $1.61 and the Pound touched $2.06 earlier in 2006. However, many analysts believe that oil has little room remaining for downward movement and a reversal of direction in oil is likely to mean the end of the dollar’s surge.

Many believe that speculation has pushed the dollar farther in recent months than fundamentals support. The Fed has rapidly dropped its fund rate and hints of more came recently from Fed Chief Ben Bernanke. It is possible the Fed could soon offer a zero per cent basis rate, similar to that offered by the Japanese Central bank early in 2007. So much for the carry trade that saw the dollar and other currencies ride high against the yen for so long. This is the essence of why many believe the dollar is in trouble. If the dollar sits at or a near a zero per cent interest base, it poses a nice target for a carry trade itself in exchange for higher earning currencies.

Carry trade is when investors essentially borrow in low rate currencies and leverage them for higher rate currencies. Speculators had long used low rate yen to buy into many other high yield currencies. An interest rate differential in currency speculation means a long-term investor can earn carry interest daily while hoping to gain profit from gains in the currency ratio.

The dollar is still in pretty good shape against some other major currencies. It earns just below 1.20 Swiss Francs at the moment. The only major currency the dollar is hurting against right now is the yen. One dollar is worth 95.16 yen, close to recent lows. It is hard to believe a dollar earned over 125 yen late in 2007. Carry trade unwinding in line with stock market selling is the major catalyst for yen gains. Speculators who leveraged the yen have been moving out of their yen negative positions for months as economic uncertainty took hold.

A weaker dollar is not all bad. It encourages foreign investment and many global US-based companies saw improved profit reports earlier this year when converting foreign currencies into more of the weaker dollars. However, a dramatic fall in a currency can cause instability in the market. Of course, instability has been all too common of late.

Market Recap

It has already been an impressive week for US equities heading into Thursday’s Thanksgiving holiday. The Dow posted its fourth consecutive positive day Wednesday with a 247 point climb. This is the first four-day rally for stocks since early spring. Jobless claims surprisingly fell to 529,000. Citigroup is set to cut 53,000 jobs. Consumer dropped by one percent in October. Markets get a respite in the US Thursday as the country celebrates Thanksgiving.

Neil Kokemuller
Wednesday, November 26, 2008
9:33 AM EST

Neil Kokemuller is an Associate Professor of Marketing at Des Moines Area Community College in Des Moines, Iowa, USA. He has a MBA from Iowa State University.

Please note: The information provided in this article is intended for informational and entertainment purposes, and not as advice for financial decisions or investments. Actions taken on the basis of the information shared is at the sole risk and discretion of the individual. Currency investment poses significant risk of loss.