The Dollar Is Up Despite Economic Weakness?!

The US economy is the midst of an economic upheaval and yet the dollar is up. The US Fed cut interest rates to induce liquidity and yet the dollar rose. The dollar’s skewed behavior seems to be a silver lining for the US currency. The dollar appreciated last week due to excess demand for the greenback arising from tight money markets and insecure banks that were unwilling to lend to each other due to the prevailing economic crisis. This created an unprecedented demand for the greenback and led to its appreciation.

It appears that the coordinated interest rate cuts by central bankers across major nations have not as yet helped assuage economic insecurity. This is also well reflected in stock market rout across major markets. Yet, the dollar is up. The reason behind the dollar’s behavior appears to be the fact that investors and individuals alike are scrambling for cash holdings instead of stocks and other instruments as the latter’s value has crashed and becoming highly uncertain. The increased demand for cash and that too, the US dollar bodes well for the currency. It appears that in times of uncertainty, the dollar is still considered as the most stable, which is the silver lining for the greenback and reflects the intrinsic perception that the amongst several currencies, the dollar is the best store of value.

All eyes are now focused on the G7 meet in the US, which is expected to hammer out financial rescue packages to assuage the ensuing economic crisis. The ironical part is that if the G7 meet succeeds in working out a package that is capable of tackling the economic crisis, the US dollar may fall! If the G7 fails to assuage the markets with a good package, the economic mayhem may continue and the demand for the US dollar is likely to be high, which may keep the greenback propped. A successful G7 economic package is also likely to instill confidence in other currencies, which may make them more attractive than they are at present and increase their demand. This can cool off the demand for the dollar, which may then see some correction.

Latest developments suggest that the G7 meet has resulted in framing the broad outline of the rescue package. The package includes the infusion of liquidity into the system and using public funds to prop banks and ensuring that the big ones do not fail. If this is correct, it appears to hold some promise, but the markets need to know what the action will be. It appears that the execution plan for the bailout packages is not in place and is likely to take some more time for various finance ministers to announce.

Thus, while the broad sentiment may have been expressed, concrete plans are yet awaited and the markets may take a cautious approach. The direction the dollar takes will depend upon how the market translates the intentions of G7 and how they are expected to be put into action.  In any case a roller coaster in the world of forex may be expected in the next few weeks, before any of the rescue packages start having a stabilizing impact.