Montreal, Canada

The odds of the Fed raising interest rates heading into yesterday’s final session of the FOMC was next to nil.

The Federal Reserve will keep rates at current levels for a long time in the absence of bank credit growth, weak credit demand, a gaping hole in financial sector intermediation and a soft housing recovery. Also, the Fed has never hiked rates when unemployment has been in a downtrend.

So what does this mean for investors – especially in currencies and bonds?
The market has taken for granted at this point that the dollar is heading into the dustbin. Longer term, there’s no doubt that the dollar is a relic and gold and other harder currencies, though few in number, will retain a higher degree of relative purchasing power.

Gold should be the big winner in this long journey of dollar debasement and eventually, replacement as world reserve currency. But that’s years away from now.

Right now, everyone is dollar bearish. And I mean everyone. Conversely, the number of bets on gold and a declining dollar are at their highest levels since before July 2008 when global markets collapsed. When everyone is on the same side of the fence, you know the trend won’t last.

At some point over the next several months the dollar will stage a significant counter-cyclical rally against most currencies. Impossible? Not at all.

Even if U.S. rates remain low into 2010, other currencies may weaken as central banks begin dumping their currencies in exchange for dollars. This might happen. There hasn’t been a globally co-ordinated central bank foreign-exchange event since the late 1990s; it’s only a matter of time until one unfolds, especially if U.S. GDP surprises to the upside over the next few quarters – which the bond market doesn’t expect.

The euro, I believe, is the most vulnerable currency right now – not the dollar. There’s a false notion or premise that everything is better in Europe. They are not. Banks are still starving for capital, liabilities are still growing on bruised balance-sheets and Eastern Europe remains a huge thorn to regional lenders. The storm has passed since March – but the weather can change.

I remain adamant that at some point over the next few years, maybe longer, the euro will be devalued as one or two currencies exit the single currency mechanism. Alternatively, if the weakest members remain in the ERM grid, then a euro devaluation cannot be ruled out.
The big winner in this scenario will be gold.

The entire gamut of currencies are competing for export market share at a time when final demand has crashed and remains stuck in a slow-growth recovery process. Things might be improving in China this year but domestic consumption elsewhere is still sluggish at best.

Over the next several months, dollar bears should stand guard. Too many investors are bearish on the dollar – similarly to 1994-1995 when the dollar last endured a multi-year decline before bottoming in mid-1995. Bet on the unexpected. Right now, nobody expects the dollar to rally.