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Has the Dollar Hit Bottom?


Slowdown in Europe could boost battered greenback.

The dollar is weak, the dollar is cheap, please tell us that it's hit a bottom.

That's what we hear everyday from our barbers and our bartenders. Dollar weakness hit a new extreme in the first quarter of 2008 with the once mighty greenback making record lows against the Euro. The most recent interest interest rate cut by the Federal Reserve has turned the U.S. dollar into the second-lowest yielding currency in the developed world.

Since then, however, it's recovered from the March lows, leaving many traders wondering whether the dollar has hit a bottom. Interestingly enough, the outlook for the U.S. economy has actually worsened, with U.S. non-farm payrolls falling for the third consecutive month. Given this deterioration, how can the dollar be strengthening, and can this rally turn into a more significant recovery?

What's Behind the Dollar's Recovery?

No news can be good news for the currency market, and this certainly seems to be the case for the U.S. dollar, which has rallied on little economic data. Consumer credit and pending home sales have been the only numbers released this week and they were weaker, which should have been dollar negative, but these numbers almost never moves markets.

Instead, the dollar is rallying because risk aversion is subsiding. This shift in sentiment is confirmed by the rebound we're also seeing in the Australian and New Zealand dollars. There is hope equity market deal flow is returning with Discover Financial Services (DFS) snapping up Diners Club. The Washington Mutual (WM) $5 billion cash infusion from investors has helped to restore some confidence in the financial markets. Whether this is enough to offset the deterioration in the labor market remains to be seen, but at least for the time being, hope is driving the dollar higher.

With non-farm payrolls behind us, no economic data poses a major threat to the greenback this week, which is why it could continue to recover. Since the March 18 Federal Reserve monetary policy meeting, the equity markets have stabilized and credit markets have eased. This tells me that for the time being, the Fed's efforts to protect Bear Stearns (BSC) have worked in preventing far more serious consequences for the U.S. economy.

Will the Recovery Continue or Will the Dollar Resume its Slide?

Dollar weakness is not over. Even though we're seeing temporary relief in the greenback, the bad news we've been seeing over the past few months will only get worse. The labor market alone is enough reason for the Fed to bring rates down to 1.50 percent.

Dell (DELL) and Motorola (MOT) joined ATA and Aloha Airlines in announcing more layoffs. These 4 companies alone will shave 14k from the U.S. workforce. Over the past three decades, the U.S. economy has gone through three recessions. During these contractions, there were a string of job losses that lasted for a minimum of 10 months.

We're already beginning to see this trend unfold and it will be months before we see the economy start adding jobs once again. The largest single month job loss in each of the recessions was more than 300k. I wouldn't be surprise to see the same degree of job losses in this business cycle because why should it be any different this time around?

For the first time in over two years, jobless claims have breached the 400k mark. If we exclude the two weeks after Hurricane Katrina, these are actually the worst levels since the last recession. Taking a look back at the time when there was a string of consecutive job losses, on average jobless claims were well in excess of 400k. This confirms that April will be an even worse month for the labor market. When traders sees a 100k drop in non-farm payrolls, they'll most certainly send the dollar tumbling.

Hey it takes two to tango. The U.S. economy is weak no doubt, but currencies are a relative game and the Eurozone economy has been slowing materially as of late. You would think that with improving labor markets and an appreciating currency, consumers would loosen their purse springs, but not so.

Eurozone retail sales fell by 0.5% compared to expectations of a 0.2% drop, suggesting that contraction, not growth, is in eurozone's future. Add to the Trade Balance registering its worst deficit this decade and you can imagine the European Central Bank (ECB) officials must be getting worried regardless of what they say publicly. If ECB President Jean-Claude Trichet drops his hawkish rhetoric this Thursday at the post rate announcement press conference, the market will start selling euro's in anticipation of rate cuts to come. So the dollar doesn't have to do anything to appreciate, it simply needs to wait for euro to weaken.


At the beginning of March, I said I was looking for the euro/dollar to hit 1.55 and dollar/yen to hit 100. Those levels have already been reached, but I think we'll still see 1.60 in the euro/dollar before there's a turn.

I think we have a better chance of seeing 1.50 rather than 1.60 on the euro/dollar, and even if we hit 1.60 that level will be temporary as ECB officials are likely to become a lot more aggressive in their rhetoric protesting the rise. The last time the euro appreciated 12% Trichet used the word "brutal" to describe the move and the unit fell 600 points in one week. A 12% rise would put the euro/dollar at 1.6200, so expect a lot more jawboning if we get there.

Fourth Quarter Dollar Recovery

Despite the fact that I think the dollar will continue to weaken, I'm a strong believer of a fourth quarter dollar recovery. The Fed's interest rate cuts should have their effect on the markets in the second half of the year at a time when the cracks that we're already seeing in the Eurozone economy become craters. The ECB will find themselves behind the curve, rushing to cut interest rates while the Fed winds down their own rate cuts. The tables will turn in favor of the dollar and that's when I expect a more meaningful dollar recovery.

I'm not so sure about the US economic recovery. I think this recession will be much worse than most analysts expect, but I do agree that ECB will find itself behind the curve and the global growth slowdown will force the ECB monetary authorities to scramble, especially if unemployment in the region once again begins to rise.

Where are the currency plays?

I've given my targets. I still like long euro/dollar, short dollar/yen and shorting Canadian dollar/yen. Economic data out of Canada is beginning to sour. I expect the Canadian central bank to continue cutting interest rates. They've previously said there's more to come, which is why I'm particularly bearish on the Canadian dollar against the Japanese yen. In fact, I'm bearish carry trades in general.

I agree on the Caddie, it looks the weakest against the buck among all the majors as markets worry about the spillover effects. However, while I'm a long term bull on the euro, I think we're in for a correction that may take us to 1.4500, so I wouldn't be buying euros now.

What Does this Mean for My Stock Positions?

Before the dollar manages to recover, more damage will be done. Japanese corporates are particularly hard hit, and I think Canadian and European companies will be as well. The Nikkei is already down significantly since the beginning of the year as Japanese companies are hit by the triple whammy of weaker sales, higher material costs, a quickly appreciating currency.

According to the Tankan report, we're well below the break-even point for Japanese corporations. Toyota Motor Corp (TM) for example said the weak dollar cut fourth quarter profit by $194 million. Yamaha Motor Co. also said they expect net profit to drop by 17 percent this year because of dollar/yen weakness. Expect more pain to be felt, which means bigger losses for all major foreign exporters.

I actually will go one better and choose China. That market was in a massive bubble and with their number one customer starting to hemorrhage, I think Chinese stocks are very vulnerable to a further sell-off so FXI (China ETF) could continue to be a good short.

For more on the dollar and euro check out Hoofy & Boo's always astute report.

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No positions in stocks mentioned.
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