Inside the US Dollar Reversal

As we all know, 2009 was a terrible year for the US Dollar. However, a strong but gradual reversal is well underway. This is mainly fueled by the Fed's announcement of extending currency swaps until February 2010. This means that the Fed is borrowing foreign currencies for US Dollars. This loan is then used for many of the Fed's strategies for strengthening the dollar during tough times. We know that the Fed is increasing liquidity with low interest rates, pumping capital into large banks to encourage lending, and supplying some foreign currencies to investment institutions who would otherwise invest elsewhere in the exchange market and further devalue the dollar. Also, the Fed can intervene in the Forex market to artificially create a reversal to fuel a rally.

This could also mean that the long period of decline has sparked foreign interest in the US Dollar. A weak dollar is not only good for trade, but also for investing. Foreign investors view a weak dollar as a bargain, and will invest for greater gains in the long run.

There are also some reasons for the dollar's short term intra day rally. The biggest reason is because of weak global economic conditions. The US Dollar's counterparts such as the Euro and Pound have experienced major declines these past few weeks. Investors are bearish on the Euro because of worries about Greece's painful deficit and potential credit defaults. The UK is a major economy that has yet to exit the recession or produce better economic data (although some newswires are quick to claim the UK is in positive territory). Also, we must factor in the UK elections; when coupled, this creates a tricky situation for the Pound.

With all of these reasons, the US Dollar has become the hot spot. The rally will continue as long as global conditions worsen. Investors should heed well to what the Fed says. Currency swaps will end in February and the Fed funding spree will become exhausted. Again, the hope is that the federal government has fueled growth. But, the real question is whether or not the markets are ready to sustain positivity on their own. So far, increasing unemployment is the major lagging indicator for the US. We have the potential to comeback, but the domestic economy must be fixed. The markets seem to be ready, but we're waiting on the politicians to act.

**charts provided by the ICE US Dollar Index**