by Marc Chandler

Take 1:   Near-Term Dollar Weakness, Longer-Term Dollar Strength

The U.S. dollar was in a multi-year bear market that had roughly begun at the start of the fourth quarter of 2000 after there was coordinated intervention by the leading central banks, including the Federal Reserve to support Europe’s new currency, the euro.  This entailed the sales of dollars.

The bear market ended like a cascading water fall.  First the dollar bottomed against the Canadian dollar and British pound in late 2007.   Next the dollar bottomed against the Swiss franc around the demise of Bear Stearns in Q1 08.   Then it bottomed against the euro around the time of the ECB’s ill-advised interest rate hike in early July 2008.

The dollar rose dramatically through the next several months as previously sold dollar commitments had to be bought back.  The dollar was used for the expansion of European bank balance sheets, by hedge funds to finance purchases of emerging markets and commodities, and by a wide range of companies and speculators throughout emerging markets, including Brazil, Mexico, Russia, and South Korea.    While there was a modest pullback in the dollar into the end of 2008, it resumed its firm tone through first quarter, before easing again the April-June period.

The corrective or consolidative phase for the dollar may persist over the next couple of months.  Interest rate differentials are such that investors are still paid to be short dollars.  However, this is likely to change.   The US economic downturn is roughly half the depth of continental Europe’s and a third of the depth of Japan’s contraction.   Yet its fiscal and monetary policies have been among the most aggressive.

Ameirca’s ability to re-invent itself and for innovation is second to none.  Unbeknownst to many, in 2008, a single U.S.-based company, IBM, was awarded more patents than China, which some say is eating the U.S. lunch.

As it becomes clear that the U.S. economy can post positive growth in either the current quarter or the next quarter, U.S. interest rates will raise above Europe’s and with a bit of a lag, the dollar will gain better traction.   Global investors, under-weight U.S. equities, will be forced to buy dollars and the U.S. will attract foreign direct investment flows as well.

Take 2:  Emerging Markets

Take 3:  BRIC or CRIB

Marc Chandler, is Chief of Currency Strategy at Brown Brothers Harriman.  He is author of Making Sense of the Dollar: Exposing Dangerous Myths about Trade and Foreign Exchange.   He appears frequently on television and writes for a number of publications on a regular basis.