DOLLAR BULLS CHARGE AHEAD
by Ghassan Abdallah, Ph.D.
February 5, 2010

The rally in the Dollar over the past month has been nothing short of spectacular with strength begetting strength, shorts being squeezed, and PIIGS being slaughtered.  Add the United Kingdom, Turkey, and Dubai to the PIIGS or Portugal, Italy, Ireland, Greece, and Spain and what do you get? STUPID.  Having this much fun should be illegal it should be against the law.  In a November article titled "The Dollar's Comeback Not Impossible," I cited several reasons why the Dollar was undervalued relative to foreign currencies.   My perspective has not changed and I view any consolidation or a slight pull back in the rally as a buying opportunity, as I strongly believe the Dollar's rally will continue throughout the balance of 2010. Whether the strength in the Dollar is due to the growing fear over European sovereign debt, the end of quantitative easing by the Federal Reserve, or short term improvement in economic activity, is irrelevant.  The fact is the trend in the U.S. Dollar Index is higher.     

THE DOLLAR INDEX       

The Dollar Index began in 1973 following the elimination of the Bretton Woods system.  Bretton Woods was a negotiated money order established in 1944 between the world's major industrial nations to govern their financial or monetary relations.  The main feature of the system was the requirement that each nation-state adopt a monetary policy that maintained the rate of exchange of its currency within a fixed value relative to gold.  The Bretton Woods system collapsed in 1971 following a decision by the United States to terminate the convertibility of the Dollar into gold.  This action created a regime where the U.S. Dollar would become the only backer of currencies and serve as the reserve currency of nation-states.   

Shortly following the elimination of Bretton Woods, the U.S Dollar Index was established in 1973 to measure the value of the U.S. Dollar relative to a basket of foreign currencies. The starting value of the Index was 100.00 and had since traded well above and well below the original 100.00 value.  The makeup of the index has changed only once in 1999 following the introduction of the Euro.  Today the index measures the value of the Dollar predominantly against the Euro and other five currencies.

DOLLAR INDEX PRESENT WEIGHT

EURO   (EUR)                          57.6%
Japanese Yen    (JPY)              13.6%
Pound Sterling       (GBP)          11.9%
Canadian Dollar (CAD)               9.1%     
Swedish Krona (SEK)                4.2%
Swiss Franc (CHF)                   3.6%

TOTAL                                    100%

The Dollar has rallied against all of the above listed currencies with the exception of the Yen.  The powerful rally appears to be more than your average arbitrary market move and more of an adjustment or a major paradigm shift.  Most pundits have attributed the rally in the Dollar to the recent credit and    uncollateralized sovereign debt problems within the Euro zone.  However, as the two-year historic chart of the Dollar Index below indicates, the Dollar's rally began two years ago in early 2008 from the 72 level.  The Dollar Index gave back or retraced most of the gains in 2009 but failed to break the 72 2008 historic low, leveling off instead at a higher low of 74, from where the rally commenced and began to gain momentum. 

U.S. Dollar Index (DXY)- Two Year Chart

As long as the Dollar Index trades above the higher low or the 74 level I will continue to be bullish on the index and assume that the primary trend is up.  I would not be surprised if the Dollar index eventually makes an assault on the 100.00 level its original value.

Disclosure- Long the Dollar Index

© 2010  Ghassan Abdallah, PhD
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Ghassan Abdallah, Ph.D | Adjunct Professor, Univ. of Houston | Email