Dollar Vs. Euro

Written By Brian Hicks

Posted October 15, 2009

I must admit. . . when it comes to the U.S. of A., I consider myself a passionate homer.

Maybe it started years ago with all those World War II movies I watched as a kid with my great uncle. He was an old sailor who was big on Admiral "Bull" Halsey — and by extension, so was I.

Or maybe it’s just because I’m much older now, and I realize just how dark the world would be without this great nation of ours. Of that much, I am sure.

So when I read last week in The Independent about a secret cabal to bring down the U.S. Dollar, my enthusiasm for the stars and stripes sagged a little. And I’m sorry to say, thanks to the dollar’s recent performance, this isn’t the first time I’ve been let down lately. . .

That’s because stories like this one pop up often these days. After all, when you run deficits the way Uncle Sam does, and you continue to watch the price of gold scream higher, the doubts begin to creep in. . . both here on U.S. soil and abroad.

When that happens, other players sell dollars instead of buying them.

From there, down it goes. . . where she stops, nobody knows.

What’s more, the Reserve Bank of Australia raised interest rates 0.25% last week, leaving everybody else in the world wondering if the dollar would ever be defended.

"Kinda sorta" was the answer we heard from the Fed.

The Dollar Index Shows the Way

As a result, the U.S. Dollar Index resumed its downtrend. This is critical to the broader markets, since the price of everything else these days (stocks, commodities, even bonds), tightly correlates to the greenback.

As it goes, so goes everything else — but in the opposite direction. A move lower, then, likely means a move higher for all the rest.

Now you can understand why the Dollar Index is the hottest indicator on Wall Street these days. It is also why it’s important to understand what the index is and how it works.

Simply put, the U.S. Dollar Index is a measure of the value of the greenback, relative to a basket of the six most tradable global currencies. These currencies float freely in direct contrast to one another.

It is important to note that within the index, not all currencies are "equal." Instead, the index is weighted, much like the Dow Jones Industrial Average.

The breakdown of the index is as follows:

  • Euro (EUR), 57.6% weight
  • Japanese yen (JPY), 13.6% weight
  • Pound sterling (GBP), 11.9% weight
  • Canadian dollar (CAD), 9.1% weight
  • Swedish krona (SEK), 4.2% weight
  • Swiss franc (CHF), 3.6% weight

That gives the index a much greater weight towards the Euro, meaning even small movements in the European currency tend to have a broad impact on the dollar.

Not surprisingly, it is the Euro’s big move higher that is responsible for the bulk of the greenback’s decline.

Dollar Vs. Euro: Keep an Eye on the Euro

As the Euro rises, European exports decline. In short, as the Euro rises, European products become more expensive.

However, a higher Euro is the last thing the Union needs right now due to their dependency on exports. Even still, the Euro has risen about 15% against the dollar since the March lows. . . and is not far from its record high of $1.60 reached in July 2008.

How long that can last is another matter entirely, especially since the EU has bore the brunt of the global rebalancing. In fact, there is already speculation that the EU would greatly prefer a much lower Euro, just to spur an increase in exports.

Besides, being short the dollar is one of the most crowded trades on the market. That’s usually a sign that a reversal is at hand.

As a result, the Euro is as much watched as the U.S. Dollar these days. This fact also leaves us with a couple of big questions, namely:

  • What happens when the Euro tops and U.S. Dollar Index turns higher?
  • Will the rally in stocks and everything else have reached its peak?

The short answer, in my opinion, is yes.

That’s why it’s important to keep an eye on the dollar-Euro relationship, since it seems to hold the key to everything else.

When the Dollar Index turns and moves higher, everything else will likely turn with it. Unfortunately, though, things will be moving in opposite directions — especially in the commodities world.

As for the true value of the dollar itself, I wouldn’t be so quick to shovel dirt on it, since holding currency is a bit like owing a share of stock. The difference is that you are buying the sum total of the country that backs it, which is one of the reasons a panicky world has always sought the safety of the dollar.

When push comes to shove, the rest of the world knows what I do about America: the United States were founded on principles that also have [economic] consequences. Among these are life, liberty, and the pursuit of happiness.

From these concepts, everything else just naturally flows. And this should be considered a monumental strength for a country — not a weakness.

Besides, if you really think that we are the only country in the world printing money and running huge deficits, then you simply haven’t been paying attention. The truth is everybody else is in exactly the same boat.

After all, the debt bubble wasn’t something that just happened to the U.S. Excess, in all of its forms, is a worldwide phenomenon.

That being said, here’s a bet we are the first ones to dig out from under it. And here’s to hoping that my optimistic sentiment isn’t just a reflection of my patriotism.

Your bargain hunting analyst,

steve sig

Steve Christ, Investment Director

The Wealth Advisory

By the way, if you are as bullish about the dollar as I am, one way to play it is to go long the PowerShares DB U.S. Dollar Index Bullish ETF (NYSE:UUP). When the "short the dollar" trade reverses, a bounce here is guaranteed.

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