     The Mighty Fed Takes a Rare Public Strong Dollar Stance by Kevin Pendley
Federal Reserve Chairman Ben Bernanke is arguably the most watched figure in the world from a financial perspective. His comments about the U.S. economy can send the markets scrambling up or down depending on the flavor of his words. He's already proven to be something of an unconventional thinker as seen by the Fed's bailout of Bear Stearns. Still, the Fed rarely makes direct comments about the foreign exchange market, typically leaving those kinds of policy stances up to the Treasury Department.
But this was no ordinary week for the Fed, as Chairman Bernanke made some fairly bold statements in support of a strong dollar on Tuesday. For instance, Bernanke said that "we continue to carefully monitor developments in foreign exchange markets" and that the dollar was a dangerous element in play on the inflation front. His direct quote here was: "We are attentive to the implications of changes in the value of the dollar for inflation and inflation expectations and will continue to formulate policy to guard against risks to both parts of our dual mandate, including the risk of an erosion in longer-term inflation expectations."
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Goldman Sachs analysts said that the Bernanke's comments suggest the Fed is moving toward more explicitly backing a strong dollar policy. They qualified this stance as "quite significant" as even the Treasury's previous public position on a strong dollar policy was vague.
In a research report, Goldman said that "This does not mean that the U.S. Treasury and the Fed would like to see a much stronger dollar. But it does mean that the U.S. Treasury and the Fed have adopted a clearer 'anti-weakening dollar policy.' All told, it signals a change is taking place and the dollar is going to take a bigger role in policy thinking from here."
The concept that a strong dollar is hampering the Fed's ability to guide the economy was also addressed this week by billionaire financier George Soros, who said that the Fed has probably approached a limit on how much more they can slice interest rates because of weakness in the dollar. "You are caught between the prospect of recession and the prospect of inflation," Soros said. He also noted that crude oil and other commodity markets were reaching bubble status, and the implication there is that if the commodity market bubble were to burst, it would undoubtedly be in tandem with a rapid strengthening of the U.S. dollar.
It is possible that the Bernanke speech marked a major turning point for the dollar. "This isn't just fluff," argued Dominic Boyle, market strategist with Lind-Waldock. "This was one of the stronger dollar approaches we've seen from Bernanke. I could envision a 7% to 12% rally in the dollar against the euro over the next three to six months," Boyle said. Although the market reaction might not be immediate, the Fed is catching the dollar on the turn, which is good timing, he said.
So, if indeed the greenback is poised to finally reverse the long-term downtrend, what are the best ways to approach a firm dollar outlook in FX markets? One obvious method to approach long dollar trades is via short euro/dollar exposure. Since I have been harping on short euro trades since mid-April and since we are already holding a short euro/long dollar position in the newsletter, I'll also put the spotlight on another method of riding a recovery in the greenback - U.S. Dollar Index futures.
The U.S. Dollar Index futures contract is traded on the ICE futures exchange. The Dollar Index was launched back in 1973 soon after the Bretton Woods exchange rate system was dismantled. The dollar value was fixed then at 100, meaning that the current value near 73.50 reflects a depreciation in the U.S. dollar of 26.5% from the index conception. The Dollar Index itself is comprised of a basket of foreign currency products, and is a weighted geometric mean of the dollar value compared to the euro, Japanese yen, British sterling, Canadian dollar, Swedish krona and Swiss franc.
The contract size of the Dollar Index is $1,000 times the index value, and from a trading standpoint, each 0.010=$10. So, a rally to 75 from 73.50 would equal a profit of $1,500 per contract. There are no daily trading limits on movement and no position limits and the index is physically settled on the third Wednesday of the expiration month. Right now, the most liquid contract month is June, but that contract will expire in less than a couple of weeks, so anyone looking to establish a medium-term position might favor the September contract for entry.
FX COLUMN TRADE CONCEPT RECAP
DATE CONCEPT PRICE THEN/NOW PROFIT/LOSS COMMENT
4/24/08 Short euro/dollar entered @ 1.5682 +0.52% stopped out at 1.5600
5/01/08 Short euro/yen entered @ 161.50 +0.12% stopped out at 161.30
5/08/08 Short euro/Canada entered @ 1.5680 +1.46% profit taken @ 1.5450
5/15/08 Short euro/yen entered @ 162.40 -0.36% stopped out at 163.01
5/29/08 Short euro/dollar entered @ 1.5525 -0.07% stops @ 1.5610 (closing)
Kevin Pendley has been involved in financial and commodity markets for two decades, including more than 15 years with Knight-Ridder Financial News/BridgeNews. In addition to his work at 4xAdviser.com Weekly, he is a contributor at SmallCapInvestor.com where he writes a weekly technical analysis column on the Russell 2000.
Any opinions expressed on this site are statements of judgment as of the date of publication and are subject to change without further notice, and may not necessarily be reprinted in future publications or elsewhere. Neither BFP nor its members, managers, officers, or employees/consultants accept any liability whatsoever for any direct or consequential loss arising from any use of its publications or their contents.
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