The Dollar has taken an incredible beating this week against all the FX Majors, but especially the Euro.  The Euro has led the charge in plummeting the U.S. Dollar to its biggest weekly decline in the U.S. Dollar Index since April of 2009.  This makes for a very interesting development.  In this report we will analyze why the U.S. Dollar is taking such a beating by market participants, and we will discuss what the possibilities are for the Dollar's future.  This chart depicts the drastic decline of the Dollar in the last few weeks.  It is coming into support around 81.50, so it may find a bit of strength next week in the near-term, but what about the long-term?

 
First of all, the fact the U.S. Dollar has seen its biggest weekly decline in the Dollar Index since April of 2009 is alarming.  The decline of the U.S. Dollar in April of 2009 was sensible.  Equity markets hit their lows and the economic recession appeared to bottom out in March of 2009.  Thus, after an incredible bull run in a flight-to-quality move by investors from the summer of 2008 through March of 2009, it was time for the Dollar to take a bit of a hit.  The Federal Reserve had lowered interest rates to near 0% due to the Global Credit Crisis, and since the economy appeared to be rebounding slowly, investors needed to get out of the Dollar and into higher yielding assets, so it was expected that the Dollar would take a hit.

And that selling of the Dollar in order to find higher yielding assets continued until November of 2009 when the Greek Debt Crisis hit.  When it became apparent that Greece and other struggling EuroZone countries were in trouble, we saw a dramatic rush into the Dollar as investors once again made a flight-to-quality as the, still very fragile, global economy was at risk.  Then, the European Central Bank and the IMF eventually put bailout funds in place for countries facing default, and the Euro finally found support at $1.1875 on June 6th.  And once a bailout was in place the Euro began to move off its LO's and the Dollar once again began to struggle.  And struggle.  And struggle.

In the last two years when the U.S. Dollar has fallen sharply, it has been due to investors seeking higher yield as the economy has improved.  This is sensible.  Then, as significant economic concerns have surfaced, the Dollar has returned to strength.  But what has developed over the last several weeks is Dollar selling no matter what's happening.  If the news is good, and investors are hopeful, they have been selling the Dollar in search of higher yield.  If the news is bad, and it is apparent the U.S. economy is struggling significantly, they are selling the Dollar.  This is what's scary.  Although it is too early to tell for sure, this could be the first signs of the U.S. Dollar losing its safe-haven status.  This could spell disaster for the U.S. Dollar because it's only strength in the last two years has been during times of economic distress.  If it can't rally during times of economic uncertainty, when will it rally?  Investors are keen on watching this development.

If the U.S. Dollar Becomes The New Funding Currency Of Choice What Would Happen To Its Value?

The carry trade is one of the most basic investment vehicles that very large hedge funds and financial institutions utilize in order to produce returns.  The carry trade involves borrowing money is a very low-yielding currency and then investing that money in higher-yielding assets, oftentimes in other currencies.  So an investor borrows $10 million at close to 0% and then parks it in an asset such as the Aussie Dollar that yields 4.25%.  Easy money!

The Federal Reserve's most recent FOMC Minutes released this week communicated that the Fed is much more dovish now than they were a few months ago.  A few months ago the Federal Reserve began raising the discount rate slightly in order to begin a return to normal monetary policy.  In fact, as near back as February or March it appeared the Federal Reserve may actually lead the global tightening cycle.  But that has all changed. 

The debacle in Europe and a slow-down in China are only helping to pull down an already very anemic recovery in the U.S.  The labor market is improving, but at a snail's pace, the housing industry appears to possibly be falling again now that stimulus has been removed, and economic growth is lagging.  This has all combined to make the Fed very dovish as they have not stated they expect the economy to take 5-6 years to truly recover.  It is safe to say rates are staying very low for an extended period of time.

But rates will not stay as low in other countries.  For example, the U.K. is facing inflationary threats and may have to raise rates soon.  Currently, it appears the EuroZone debt fiasco is under control.  Greece, Italy, Portugal, Spain, and Ireland have adopted massive austerity measures as they have slashed government spending in order to bring their houses in order.  If this actually works in the EuroZone, and they return to growth sooner than the U.S., and they enter the tightening cycle before the U.S. does, it could spell disaster for the U.S. Dollar.

At that time investors will be focusing on the yield spread between the U.S. and other countries, and if that happens, we could see a run on the Dollar that we have never seen before.  There would be no impetus for investors to hold U.S. Dollars.  If economic meltdown is not an imminent threat, and investors are getting a very low yield on investments, why hold Dollars?  Well, the short answer is there is no reason, and that could be a very big problem.