Dollar Gains Most Since May 2005 Versus Euro as Inflation Rises

[swag]

Source: Bloomberg

Dec. 14 (Bloomberg) -- The dollar advanced the most against the euro since May 2005 after the biggest increase in consumer inflation in two years prompted traders to pare expectations for interest-rate reductions.

The dollar gained against 13 of the 16 most-actively traded currencies as futures show the probability of a Federal Reserve rate cut in January declined from 100 percent. The U.S. currency has risen 1.5 percent against the euro over the past five days, the biggest weekly increase since August.

``The fundamental picture started to move in the dollar's favor,'' said Michael Malpede, a senior currency analyst in Chicago at MF Global Ltd., the world's largest broker of exchange-traded futures and options contacts. ``Inflation is picking up, making it difficult for the Fed to aggressively cut interest rates.''

Against the euro, the dollar rose 1.38 percent to $1.4432 at 11:47 a.m. in New York, from $1.4633 yesterday. It strengthened to 113.41 yen from 112.21. The dollar touched $1.4421 per euro and 113.44 yen, both the strongest levels since November. The euro fell to 163.55 yen from 164.21. The pound weakened to $2.0202 from $2.0414 yesterday. The Swiss franc declined to 1.1536 per dollar from 1.1412.


Read more: http://www.bloomberg.com/apps/news?pid=20601087&sid=a.qT6Y_DL6aM&refer=home

[Fenris]

1. So what do you think

Is the dollar going to keep advancing?

[dantyrant]

2. No.

This is an indication of a spasm in the global economy, as far as I can tell... We're seeing the effects of deflation kicking in across the board with all markets and commodities somehow managing to decline at once... yet the dollar goes up somehow? Against all global currencies, and gold? Even though inflation is finally being acknowledged? I'm not an economist, but even I can tell things are out of whack.

Here's one plausible explanation for the apparent weirdness:

The United States has created an odd dollar zone drawing in China and the Persian Gulf. (Other energy producers such as Russia, Nigeria and Venezuela have no problem using their dollars internally.) Unhinging China from the dollar is impossible; it sells in dollars to the United States, a linkage that gives it a stable platform, even if it pays relatively more for oil. Additionally, the Arabian Peninsula sells oil in dollars, and trying to convert those contracts to euros would be mind-bogglingly difficult. Existing contracts and new contracts managed in multiple currencies -- both spot and forward managed -- would have to be renegotiated. Any business working in multiple currencies faces a challenge, and the bigger the business, the bigger the challenge. The Arabian Peninsula accordingly will not be able to hedge currencies and manage the contracts just by flipping a switch.

This provides an explanation for the resiliency of U.S. markets. Every time the news on the subprime situation sounds so horrendous that it seems the U.S. markets will crash, the opposite occurs. In fact, markets in the United States rose through the early days, then sold off and now have rallied again. Where is the money coming from?

We would argue that the money is coming from the dollar bloc and its huge free cash flow from China, and at the moment, the Arabian Peninsula in particular. This influx usually happens anonymously through ordinary market actions, though occasionally it becomes apparent through large, single transactions that are quite open. Last week, for example, Dubai invested $7 billion in Citigroup, helping to clean up the company's balance sheet and, not incidentally, letting it be known that dollars being accumulated in the Persian Gulf will be used to stabilize U.S. markets.

This is not an act of charity. Dubai and the rest of the Arabian Peninsula, as well as China, are holding huge dollar reserves, and the last thing they want to do is sell those dollars in sufficient quantity to drive the dollar's price even lower. Nor do they want to see a financial crisis in the U.S. markets. Both the Chinese and the Arabs have far too much to lose to want such an outcome. So, in an infinite number of open market transactions, as well as occasionally public investments, they are moving to support the U.S. markets, albeit for their own reasons.

It is the only explanation for what we are seeing. The markets should be selling off like crazy, given the financial problems. They are not. They keep bouncing back, no matter how hard they are driven down. That money is not coming from the financial institutions and hedge funds that got ripped on mortgages. But it is coming from somewhere. We think that somewhere is the land of $90-per-barrel crude and really cheap toys. (Link)

[Jackpine Radical]

3. You're right.

The thing that struck me was how paradoxical it seemed for the dollar to respond to inflation (i.e. losing value) by gaining value! This is nuts on the face of it, but the dollar gains value from all the desperate rescue efforts on the part of all those rich foreign interests who haven't figured out how to unload their dollar investments.

[amandabeech]

5. In inflationary times, interest rates go through the roof.

The U.S. government, and the rest of us, borrow like crazy.

A couple of weeks ago, was it, that the treasury cut interest rates to keep the housing market from crashing and the junk CDO's from losing all their value.

Now it appears that consumer inflation is increasing, so the treasury can't keep cutting rates or else inflation will go crazy.

It must now balance between raising rates to counter inflation and cutting rates to keep mortages and derivatives from falling apart.

The treasury is in a bad position,

but if it has to keep interest rates higher to stop inflation, the dollar will go up.

That is, until the whole thing tanks.

[AndyTiedye]

6. It Gained Because Interest Rates Didn't Drop As Much as Expected

That's also why the stock market went down.

Everybody expected Ben to start up his helicopter and he didn't.

[robcon]

7. I think it is your analysis that is nuts.

Jackpine Radical wrote: "The thing that struck me was how paradoxical it seemed for the dollar to respond to inflation (i.e. losing value) by gaining value! This is nuts on the face of it... "

The dollar's decline is partially driven by the lowered interest rates by the Fed (short-term money has been converted from, for example, dollars into currencies that have higher interest rates, e.g., yen/Euro.)

The recent lowered value of the dollar will increase the price of imported goods. which has three effects: decreased U.S. imports, increased U.S. exports and increased U.S. inflation.

The article recognizes that the Fed can't lower interest rates much lower due to the added inflationary implications of that action... thereby decreasing expectations that the dollar will continue to decline.

Expectations drive inflation.

[swag]

4. Hard to say, contrary to what some here believe.

If I had to guess, I'd say that it's going to clang around in that $1.40-$1.50/euro range for a while.

A consensus of economists surveyed by Bloomberg see $1.40/euro by year-end. Of course the consensus predictions are often wrong.

Do you have any guesses? Gonna go long on GLD?

[Fenris]

8. The radio people tell me I should invest in GLD at least once an hour.

I'd say the Bloomberg economist poll is a bit optimistic, and that I would guess it will end the year around $1.48, plus or minus two cents. But who knows - it's volatile right now, and that's probably not going to change before Jan. 1.

[Oreegone]

9. Rupert Murdock

Did Rupert buy Bloomberg too? We should just get glowing reports about the economy now that the Stock Market is in his hands. This shit is just crazy.

[roamer65]

10. With M3 growth advancing at a 16% annual pace...

I am going to bet against the dollar. We haven't seen this kind of M3 growth since Tricky Dick closed the gold window in August, 1971.

[JCMach1]

11. It's not just the US though... Europe also has a 'little'

balance of trade problem...

And inflation, yikes!

[Javaman]

13. but they don't release the M3 numbers anymore!!

can't have the american prols knowing how much currency is circulation!

[Zynx]

15. Where is this evidence of 16% money supply growth?

[Javaman]

12. interesting how the dollar started advancing before it hit a low of 50 cents

and isn't it also interesting that oil prices went down before hitting a high of $100 bucks.

couldn't possibly have anything to do with the holidays, could it? naaaaaaaaaaaaaaaaaaaaaaa, perish the thought. That would mean that there are people out there actually manipulating the values.

Now just you all shut up and go save the nation by shopping!!!

[Zynx]

14. Long term the trend on the dollar is still bearish.

It still needs to decline further in order to help to correct our trade deficit, which it has started to do. However, in the short term it is oversold and should bounce somewhat.