Kiss the dollar rally goodbye

Another Fed rate cut and concerns about the government's ballooning bailout price tag means that the greenback's recent run against the euro is likely over.

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By Paul R. La Monica, CNNMoney.com editor at large

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Have the Fed's rate cuts helped the economy?
  • Yes
  • No
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The greenback rallied against the euro this fall but has started to lose ground once again. Click on the chart for more currency rates.

NEW YORK (CNNMoney.com) -- It wasn't that long ago that the dollar was strengthening against the once-mighty euro, leading anyone that could still afford a plane ticket to Paris to celebrate that they could suddenly get more baguettes for their buck.

But what a difference a Fed rate cut and more bailouts make. Since the Fed lowered rates to 1% in late October, the euro has gained 10% against the greenback.

During that time frame, the government has also been forced to essentially print more money to help pay for several new initiatives aimed at boosting the flagging economy.

Well, guess what? The Fed cut interest rates again on Tuesday to a target of between 0% and 0.25%. And the government is likely to add more to the bailout tally before the end of the year with an emergency loan to keep General Motors (GM, Fortune 500) and Chrysler LLC from bankruptcy.

So what will this do to the dollar? Is it possible that it could once again slip to the all-time low it hit against the euro back in July when oil prices were at record levels?

That may not be likely anytime soon. Even after factoring in the euro's recent spike -- it jumped to about $1.413 after the rate cut Tuesday -- the euro is about 12% below its peak of $1.6038.

Brian Dolan, chief currency strategist at online currency trading site Forex.com, said that he thinks that the dollar is probably fairly valued between $1.35 and $1.40.

But he said that it's possible the euro could strengthen further, possibly to $1.45, because even though some think the Fed may eventually even lower interest rates to zero, the European Central Bank has hinted that it may keep rates steady at its next meeting in January instead of cutting them again. The ECB slashed its key lending rate to 2.5% earlier this month.

"The U.S. has been more proactive and aggressive in attempts to support the economy while Europe has been viewed more as dragging its heels," Dolan said.

Along those lines, another currency strategist suggested that the euro could even approach $1.50 once it becomes more evident that the ECB is going to pause.

"Once we get a clear sense that the ECB is done cutting interest rates, then the dollar will be under more pressure," said Ashraf Laidi, chief market strategist with CMC Markets, a currency brokerage.

Dolan said that one key reason the dollar had rallied against the euro in the late summer and early part of the fall was that even with the credit crisis starting to take hold, the U.S. was still viewed as more of a safe haven than Europe. But as more and more data point to an increasingly ugly picture for the U.S. economy, that may no longer be the case.

"A lot of the dollar's strength of the past few months was defensive and not sustainable so that's part of the reason for the giveback against the euro," Dolan said. "The real driver now is how bleak the assessment for the economic outlook will be. Investors are trading more on sentiment than any kind of absolute interest rate levels."

Still, Laidi said that the combination of super-low interest rates and all the money that the government will need to borrow to pay for bailouts, fiscal stimulus and other programs to boost the economy is likely to lead to further declines for the greenback versus both the euro and Japanese yen.

The yen has gained ground against the dollar in the past month and a half, but not as much as the euro. Its increased about 2% since late October. But the yen is up 23% versus the dollar year-to-date.

Laidi explains that the yen is benefiting since Japan, which also has low interest rates, is viewed as a better place to park money than the U.S. right now because Japan's budget deficit, as a percentage of its gross domestic product, is lower than that of the U.S.

Add all that up and this makes the yen, as well as the euro, more attractive than the dollar for the short-term.

"Today's Fed rate cut is one step closer to zero percent for interest rates. The U.S. budget deficit combined with falling interest rates is a negative for the dollar. It makes selling the dollar the path of last resistance," Laidi said.

To be sure, there are some benefits to a weaker dollar. It may help boost profits at huge multinational companies like General Electric (GE, Fortune 500), Procter & Gamble (PG, Fortune 500) and Coca-Cola (KO, Fortune 500), to name a few.

But a sagging greenback also tends to lead to higher prices for imported goods. That could trigger another bump in commodity prices, such as oil.

Eventually, a weak dollar may also force long-term bond yields higher in order to make them attractive enough to foreign investors. If that happens, that could lead to higher rates for variety of consumer loans.

So it's probably not encouraging to see the dollar slowly drifting back up again. In this economy, consumers simply can't afford another piece of bad news that will hit them in the pocketbook. To top of page

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