Fed signals lower dollar

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By Shavasb Bohdjalian 

The dollar sank to a three-year low against a basket of major currencies last week after the Federal Reserve said it would end its bond-buying programme in June as planned but appeared in no rush to tighten monetary policy further.
In one small revision, economic growth was described as "modest" rather than "on a firmer footing" as before. The slightly more downbeat assessment was reflected in a downward revision to the Fed's GDP growth forecast for this year to a range of 3.1% to 3.3%, from 3.4% to 3.9%.The Fed did raise its PCE inflation forecast for this year to between 2.1% and 2.8%, from a range of 1.3% to 1.7%. The statement also acknowledged that inflation had risen in recent months although, with core inflation "subdued" and inflation expectations "stable", it will not prompt any response from the Fed.
Fed Chairman Ben Bernanke also gave a little extra insight into the Fed's commitment to leave rates at exceptionally low levels for an "extended period", revealing that when that commitment is finally dropped, it would signal that it would still be "a couple of meetings before action." Bernanke didn't completely rule out the possibility of a third round of asset purchases if required either. Bernanke went slightly further in the press conference, revealing that "when we complete the [QE2] programme we are going to continue to reinvest maturing securities."
He went on to say that "an early step [in the exit process] would be to stop reinvesting all or part of the securities that are coming in." There has been some speculation that the Fed could stop reinvesting any returned principal quite soon after, if not at the same time as, it stops buying Treasury securities at the end of June. The Chairman's comments suggest it won't happen until much later than that, possibly not until the Fed is almost ready to hike rates.
A Reuters poll showed most U.S. primary dealers expect the Fed to keep interest rates near zero until the end of 2011. By contrast the European Central Bank has already raised and the Bank of England are seen likely to raise interest rates later this year. The dollar index has slid nearly 4% this month, bringing it closer to a record low of 70.698 hit in March 2008.
With the Fed in no rush to raise rates and promising to flood the market with cheap money and keep reinvesting the bonds proceeds back into the market, analysts expect this policy to continue to favour share prices, push commodities and oil further higher and force the dollar even lower than it already is.
As JR Crooks, chief of research at investment advisory firm Black Swan Capital told Reuters, "The biggest risk right now is that Bernanke's looseness creates the unintended consequence of boom-goes-bust, where easy-money-driven asset bubbles implode and confidence is consequently sucked out of the economy."
"It's one thing to have a currency on the decline; it's another thing to have GDP on the decline."
The Barclays' G10 carry excess return index shows that borrowing in low-yielding currencies such as the greenback and buying those with high interest rates like the Australian dollar has generated returns of about 37% so far since the end of the financial crisis in early 2009.
"The Fed seems to be in no rush to tighten monetary policy. So if rates remain low, why shouldn't the dollar be the preferred funding currency?" Thomas Stolper, chief currency strategist at Goldman Sachs in London told Reuters.
I guess the big question that one should ask, is what can go wrong? Many things. For one, the market is over-stretched and there is a good possibility for profit taking. Oil could turn lower faced with a slowdown in US and other economies. Tightening in Asia could force commodities lower and last but not least, we may still have the debt restructuring plan in Greece or an Irish bank going under, but until such surprises finally hit the newswires, the market believes that selling the dollar and buying everything else except the yen is the preferred choice of investment.