Myth of the Year: The Dollar is Getting Killed

For much of 2009, the big story has been the dollar's weakness. The dollar index put in a significant top for the year in March coinciding with the bottom in the equity markets. It has been dollar down and equities up ever since with the DXY down 16% and the S&P 500 up 66% from the early March turning point.

In recent months, the dollar's decline has actually been fairly controlled trading lower within the confines of a steep descending channel. As the decline has become more methodical the attention it has received in the press has seemingly increased markedly. While this is surprising, I believe it is due to the breakout in gold prices to new all-time highs. Gold's breakout has forced traders to be acutely focused on the dollar's movements and its relationship with dollar-priced assets. Any active trader realizes that he must be watching the dollar in today's markets as a leading indicator.

The dollar index now trades around 75.50 which is still 6% off the 2008 lows. The DXY spent much of 2008 trading around the 71-74 area prior to the major actions by the Federal Reserve. The late-2008 sharp rally in the dollar was fueled by a significant dollar supply contraction as trillions of wealth evaporated in the post-Lehman bankruptcy panic and an unprecedented flight to safety sparked a burgeoning demand for dollars.

As the panic has subsided and most assets around the world have rebounded, the dollar is falling back to normalized levels. The idea that the dollar is "getting killed" is misplaced as it is simply a reversal of the sharp rally. The increased media attention has many believing the dollar is being completely destructed yet it remains above last year's pre-rally lows when all was still relatively okay in the world and only Bear Stearns had paid the price for the excesses in the system.

Yet, the dollar may have much farther to fall. The dollar rally started in July 2008. The index was trading lower prior to many of the policy actions taken to stem the fallout in late-2008. The Federal Funds Target Rate was 2% prior to the July rally and now stand at 0-0.25%. The monetary base more than doubled in late-2008 significantly impacting the value of the money already in the system. The dollar has a lot of reasons to be trading significantly lower than last year's range which would put it at new all-time lows.

So, while 2009's Myth of the Year may have been that the dollar was getting killed, it may be 2010's Reality of the Year.