The U.S. dollar has an inverse relationship with a variety of markets, so if you have a read on the currencies, you should have a read on other markets. Let’s talk about the situation we are in right now in the U.S. from an economic standpoint, and how foreign currency policy decisions can have a powerful impact.
Many analysts and economists feel we need at least 4 percent growth in gross domestic product to bring unemployment below 8.5 percent by 2012. In 2011, stimulus will likely prevail. Federal Reserve Chairman Bernanke’s aggressive expansion of the Fed’s balance sheet (mainly through U.S. Treasury purchases) known as quantitative easing (QE) could help deliver some of that growth. I’m optimist, but these are uncharted waters. We’ll have to wait and see what the Fed delivers over the next few months, and whether it works.
China and the Yuan
You might not realize just how currency valuations can impact our economy. A falling dollar can fuel increased exports, and drive GDP growth. A 15 percent revaluation of China’s currency, the yuan (from 6.66 yuan per dollar to 5.66 yuan per dollar) could potentially reduce the U.S. trade deficit by $60 billion and result in employment for some 500,000 U.S. workers. In fact, if all foreign currencies were revalued by 10 percent against the dollar (meaning a 10 percent devaluation of the dollar), that could potentially reduce the trade deficit by $180 billion in a couple of years. And, it could cut unemployment by about 1.5 million workers, a drop of about 1 percent in the unemployment rate.
Bernanke’s QE policy has already caused the U.S. dollar to drop about 10 percent since the beginning of 2010, and another round (QE2) could bring the dollar down another 10 percent, back to its 2000 level. QE can devalue the dollar against floating currencies (such as the euro, yen, and Canadian dollar) but it can’t change the relationship between the dollar and yuan as long as China is determined to maintain the peg and accumulate foreign exchange reserves.
Short-Term Dollar Outlook
I think the dollar should continue to drop as long as quantitative easing is in play as a policy. Short-term, however, the dollar looks oversold. (See chart of the December dollar index futures below). I expect a move up to near the 50-day moving average at 80. There is also a bullish signal in the MACD. I would not go all-in, however. It is likely to be a corrective bounce, not a near bullish trend until we know what stimulus the Fed will give us, and for how long.
That being the case, I think gold is likely to remain supported. As long as the dollar remains weak, and the economic outlook uncertain, gold bugs should be rewarded. Traders might consider buying on corrective dips until the fundamental—and technical—picture changes.
Richard Ilczysyn is a Senior Market Strategist with Lind-Waldock. He can be reached at 800-605-0095 or via email at rliczyszyn@lind-waldock.com. You can follow Richard on Twitter at www.twitter.com/LWRIlczyszyn.
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