Recently the US dollar fell to a record low on speculation that the Federal Reserve would cut interest rates again. Against the euro, the greenback's spot rate weakened to a level above $1.44. The slump in the housing market which has hurt the US economy has also caused the weakness of the dollar.
The Fed is presently holding a two day meeting and a further cut of the federal funds rate is widely expected. During the last meeting on September 18, Chairman Ben S. Bernanke unexpectedly, and aggressively, cut the target rate for overnight bank loans by 0.5 per cent to 4.75%. This was the first rate cut since 2003 after losses from subprime mortgage investments spooked the credit markets, resulting in a severe credit crunch.
Ironically, in August, the dollar actually profited at first from the panic at the stock markets. However, the status of 'safe haven' was short lived. The rally of the euro versus the dollar which then followed was fuelled by the decreasing rate differential between the two world leading continents.
Euro more attractive
The European Central Bank was not able to cut its interest rate (4%), since the euro region's economy was still strong and, more importantly, inflationary pressure in Europe stayed high. To fight recession the Fed had to cut the federal funds rate. The result - the euro became more attractive than the dollar.
Last week, the dollar hit a record low versus the euro and the US Dollar Index also fell to a new low, under 77, in October. The US Dollar Index consists of six foreign currencies: the euro, the Japanese Yen, the British Cable (GBP), the Canadian Loonie (CAD), the Swedish Crown and the Swiss Franc. This index is a pretty good tool for measuring the US dollar's global strength.
Predicting the dollar
Although the dollar is very weak and hovering near all time lows, if the US economy can shrug off the credit crisis and manages to recover again, this could result in a significant rally.
Sure, many analysts and market participants expect the dollar to fall further. But do keep in mind that the dollar could strengthen again. Considering the fact that the currency is oversold, a few positive events in favour of the dollar could instigate a rally, which could also be fuelled by short coverings.
One such event could be that the Fed does not lower the interest rate further this year or perhaps that the US economy does indeed strengthen again. A proper strategy could be to partly close short positions in the dollar, in order to keep profit potential combined with reduced risk. No one is able to control market prices, but one can, and must, control risk.