The U.S. dollar continues to get a lot of press for its recent declines, and many market analysts and economists alike ponder the potential implications. Just last week the dollar declined to a 20-month low against the euro, based on unexpected bad economic data coming out of the United States, which reduced the chance of higher interest rates emanating out of the largest economy on the planet.

The euro, which is the currency of 12 countries, traded to its highest level since March of 2005. This surge was based on the recent economic data that showed durable goods orders having their biggest decline in more than six years, the median home price seeing its biggest drop ever and consumer confidence declining to its lowest point since the month of August.

Typically, raising interest rates is a weapon used by the Federal Reserve to combat inflation. Of course, higher interest rates generally bolsters that country's currency by rendering investments in that particular denomination much more attractive. The euro has also been strengthened by expectations that the European Central Bank will continue to hike rates due to some surprisingly robust European economic data while at the sane time expecting the U.S Federal Reserve to hold or subsequently even reduce interest rates.

Many economists genuinely expect that the weakening U.S. housing market will be a burden for the economy and that we will see the dollar to continue to weaken. This could adversely impact European exports, especially if the euro continues to make new highs in the marketplace. However, some economists point out that the labor market is still strong in the United States, which could bode well for a more gradual slowing in the economy.

Currently, there is no doubt that the Federal Reserve is keenly honed in on the various economic reports being released over the next few weeks. Right now the market is expecting the Fed to do nothing over the next couple of months and then will lower interest rates sometime in 2007.

As always, it is a two-way street when looking at the economic impacts of an anemic dollar. For strictly domestic companies it can be harmful because it decreases Americans' purchasing power, which reduces their spending. However, for international companies like McDonalds Corporation (MCD) and the Coca-Cola Company (KO) is can be a boost to earnings as the weaker dollar makes U.S. goods cheaper for foreigners and therefore much more competitive in the global market.

Some nations like China are actually being proactive in keeping their exports cheap by controlling the value of their currency. For example, in the case of the yuan, which is the Chinese currency, daily movements are limited to 0.3 percent above or below the official level. Ironically, though, currency traders and economists point out that another reason the dollar is falling is due to the belief that China is reducing its amount of dollar denominated holdings in favor of other currencies.

The People's Bank of China refused to acknowledge however that Beijing is moving its foreign reserve holdings away from the U.S. Treasury market. The U.S. Treasury Department admitted that foreigners sold more Treasuries than they purchased in September for the first time in the last 42 months. This particular selling spree was led by Japan, which is biggest holder of U.S. Treasuries.

Many economists firmly believe that the long-term factor behind the declining dollar is the broadening current account deficit in the United States. Currency traders contend that the dollar is just now catching up with the fact that America is deep in debt. On the other hand former Federal Reserve Chairman Alan Greenspan indicated recently at an investor conference that worries over the dollar are unwarranted provided the U.S. economy remains flexible. The bottom line is that only time will tell with potential huge impacts on both the equity and debt markets lurking around the corner.

Happy Trading.


Jeff Neal
Senior Writer, Options Strategist & Profit Strategies Radio Show Market Correspondent
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