Something unusual is happening at the Fed…

Ben Bernanke, FOMC Chairman, boosted the value of the U.S. dollar yesterday in a rare public admission of tacit dollar support. This marks the first time since the Bush Administration came into office in 2001 that the Fed has publicly supported a “strong dollar” policy.

Over the last decade and beyond, the Treasury has been the center of vocal dollar support even though the majority of policymakers quietly favor a weak currency. The United States has been desperately trying to curb its massive trade deficit over the last 20 years. One way to cut foreign imports is to unofficially support a weak currency, which makes foreign goods more expensive. Low rates encourage dollar selling. This decade the Fed has cut rates below 3% on two occasions – first under Greenspan in 2003 and now under Bernanke to 2% since April.

The markets won’t follow the Fed’s lead supporting the dollar. I don’t expect anything more than a dead-cat bounce that might last a few weeks or several months at the most.

The dollar, which is already heavily oversold versus the majority of currencies – especially in Europe, Latin America, Australia and Canada – won’t post a meaningful recovery amid a recession developing in the 2nd quarter.

Since January 1st, U.S. bankruptcies have surged 25% through May and are up a staggering 39% over the last 12 months. Housing prices are still in a major freefall, bank credit is contracting under the weight of even more write-downs and the consumer is paring back spending to basic essentials like food and energy.
If you’re a buyer of the dollar at these levels because you think the economy is bottoming and the Fed likely to raise interest rates, think again. This will be a long road to recovery. The banks are mired in a pile of bad loans, illiquid securities tied to a host of synthetic products and saving their precious cash for top caliber loans. This is not an environment that’s conducive to long-term dollar accumulation.

The dollar doesn’t have to plunge from these levels. It already has. But it also doesn’t have to rally because I can’t find a compelling reason to accumulate this currency under the weight of so many economic problems.