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Look for a Rebound in the Oversold Dollar

Tuesday, 12 Oct 2010 12:39 PM

The value of the U.S. dollar compared to a basket of other major world currencies fell sharply during the past four weeks in response to traders’ expectations that the Federal Reserve will soon enter a new wave of so-called quantitative easing by purchasing massive amounts of U.S. government and/or government-agency securities.

Although any such purchases by the Fed would normally cause the exchange-value of the dollar to fall as the Fed increased the supply of dollars, my experience suggests that the dollar will rebound during the weeks ahead.

That’s because my research indicates that the Fed will not purchase anywhere near the amount of government and/or government agency securities that most market participants expect — and because the central banks of numerous foreign governments will likely increase their purchases of U.S. Treasury securities in an effort to halt a potential continued decline in the exchange-value of the U.S. dollar.

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U.S. commercial banks already have almost $1 trillion in deposits to lend to their customers, borrowing rates are currently near historic lows, approximately 17 percent of the U.S. workforce is unable to secure a full-time job, and American households are currently more interested in paying down debt than borrowing money to spend on unnecessary discretionary items. Those factors suggest that any substantial purchases of U.S. government securities by the Fed would fail to stimulate borrowing and spending.

Meanwhile, a new wave of quantitative easing might cause long-term interest rates to rise because any such purchases would likely lead to a continued decline in the exchange-value of the dollar and to people thinking that such a decline would cause inflation rates to rise.

With the Federal Reserve being aware of those likely consequences, I’m convinced that the Fed will not enter a new wave of quantitative easing.

Separately, foreign governments have an implicit interest in maintaining the exchange-value of the U.S. dollar. That’s because economies of many countries around the globe are heavily dependent on exports to the United States.

If the exchange-value of the U.S. dollar were to fall sharply, the prices that Americans would pay for foreign goods and services would likely rise sharply and Americans would therefore likely reduce their purchases of such goods and services. Recognizing that fact, countries such as China, the United Kingdom, Brazil and Japan would likely increase their purchases of U.S. dollars to halt a continued decline in the exchange-value of the U.S. dollar.

Central banks in the countries mentioned above, as well as in numerous other countries, already increased their purchases of U.S. dollars during July – the latest month for which data is currently available – and I expect that trend to continue during the months ahead.

I therefore urge you to not fall prey to some persons’ claims that the dollar is doomed to continue its recent descent.

Note from Moneynews:

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About the Author: David Frazier
David Frazier is a member of the Moneynews Financial Brain Trust. Click Here to read more of his articles. He also writes two very successful investment newsletters. Discover more by Clicking Here Now.

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The value of the U.S. dollar compared to a basket of other major world currencies fell sharply during the past four weeks in response to traders expectations that the Federal Reserve will soon enter a new wave of so-called quantitative easing by purchasing massive amounts...
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