Dollar’s dilemma: To rally or not

The Dollar index has been hovering near support for three weeks now, unclear if it wants to rally or break down. This week is crucial for dollar’s direction.

Technical charts right now are unclear about the medium-term direction of the dollar. In the past three weeks, the dollar index has been moving in consolidation range showing indecision in the market.

Two key events this week can push the dollar —- the US Congress elections and the Federal Reserve’s meeting where it will decide on the extent to which to debase [quantitative easing] the dollar.

It is widely believed that the business friendly Republican party will win the elections and that’s already discounted by the dollar index. Victory by a broad margin is positive for the dollar and vice versa. The polling is on Tuesday and the result will be out by Wednesday.

However, the Fed plans a second round of quantitative easing on Wednesday. Again, the market has already discounted the easing, though its extent is not clear. Larger the liquidity pumped in, greater will be the dollar’s fall.

So, the dollar should take some direction by Wednesday, though it’s possible that the dollar-positive and dollar-negative events cancel each other out, leaving the greenback where it is.

Pumping money into the system never works in the long term. The Japanese economy is a prime example. The Japanese authorities tinkered with money supply after the markets peaked in 1990s. After initially hiking rates, the Japanese have been on a continuous easing spree. The results are in. The Nikkei 225, which was 40,000 in 1990 is today at 9200. The Japanese yen in the same period has moved between 80 and 147. At 80 now, the yen is at an all-time high against the dollar. So much for trying to devalue the yen and boost exports.

However, unlike the yen, which is not treated as a reserve currency, the Fed’s dollar decision will have long-term consequences on the global economy. If the dollar eases, other currencies could rally, increasing the cost of commodities and spurting inflation in developing economies.

However, technically speaking, the dollar is near some crucial support areas and has a greater chance to rally. The 75 area on the dollar index is a strong support. The index closed at 77.27 on Friday. After that, the next support area is between 70.70 and 72.50.

The writer is editor, www.capturetrends.com, and based in Chicago