Faster, Higher, Stronger

In a previous post I discussed the recent rise of the US dollar. A number of factors have converged to support the greenback's reversal, and on a technical basis key resistance points have been breached in recent trading. Some reacted to my prediction of a sustained dollar rally with understandable skepticism. However, the past few weeks have reaffirmed the trends I believe will support a strong dollar. A few key points:

-The long commodities/short financials trade the fueled the speculative bubble is rapidly unwinding. This has weakened commodity currencies like the Aussie and Kiwi dollar, and seen a surge of money back into the greenback. The record losses of hedge funds in 2008 are directly tied to this trade. While I support the view that rising commodity prices are mainly attributed to fundamental shifts in supply/demand/capacity, financial speculation has clearly generated the froth. I believe the fundamentals support $100 oil, but $140 was all about the hot money.

-The US pleasantly surprised with a revised 3.3% Q2 GDP growth (although some are questioning the credibility of this figure). The expansion was mainly driven by exports, which have surged on the back of a weak dollar. While a strengthening dollar will nudge down exports levels, a measured increase in domestic consumption should keep the US economy above water in Q3 (fiscal stimulus typically takes 2 quarters to fully work its way through the real economy).

-Europe is on the brink of a formal recession, and according to Alastair Darling, economic conditions in the UK are the worst since WWII (how's that for confidence!). Sterling's slide continues, hitting its weakest level since the Euro's introduction in 1999, while the dollar reached an eight month high against the common currency in today's trading.

-Finally, the risk of at least one currency crisis in Asia has increased this week. There are reports that a number of central banks intervened to support their currencies (Thailand, South Korea, Malaysia, the Philippines). The conditions in Asia are uncomfortably similar to 10 years ago (although granted, large FX reserves and better financial supervision have countries like S. Korea better positioned to withstand a run). South Korea has already fired a warning shot to speculators, and the IMF publicly weighed in today in support of the won. With the political situation in Thailand deteriorating by the minute, it could well be the first shoe to drop...just like in 1997. Needless to say, expect a flight to safety ($).

No one should expect the dollar to hit the stratosphere any time soon. But a measured, sustained rise looks even more likely now than it did at the beginning of last month.