Bet your bottom dollar
The Fed's last two rate cuts helped send the greenback drastically lower. But experts say the worst may be over for the dollar - even if the Fed lowers again.
NEW YORK (CNNMoney.com) -- Wall Street is betting that the Federal Reserve will deliver another rate cut at its policy meeting Tuesday, but that may not necessarily spell more doom for the dollar.
Currency experts argue that the greenback's steep decline this year has come too far, too fast and that investors have factored in one, if not more, rates cut by the Fed in the coming months.
"At these levels quite a bit of interest rate reduction is already priced into the dollar," said Shaun Osborne, chief currency strategist in Toronto at TD Securities Inc.
The dollar has managed a modest recovery in recent weeks, but is still sharply lower for the year against a number of currencies, most notably the euro and the British pound.
The U.S. Dollar Index, which measures the currency's performance against six of its biggest trading partners, is down more than 8 percent so far this year, after hitting a record low late last month.
Much of the dollar's recent decline can be blamed on the Fed's recent policy actions. In October, the central bank cut the key federal funds rate, which affects the rate at which consumers borrow on a variety of loans, by a quarter of a percentage point. That followed a half-point cut in September.
A rate cut puts pressure on the dollar since it makes dollar-denominated investments less attractive to outside investors.
Although a weak dollar also typically drives domestic and overseas demand for U.S. goods, it also poses an inflationary risk to the economy by limiting consumers' buying power overseas and pushing up the price of commodities such as oil and gold.
Traders are split as to whether the Fed will lower the federal funds rate by a quarter-point or a half-point on Tuesday.
But Tom Fitzpatrick, global head of currency strategy at Citigroup in New York, said that if the Fed cuts by a half-point, he thinks there would be "quite a sharp reaction in terms of dollar selling."
With a rate cut all but certain though, Fitzpatrick and other currency experts said investors are likely to pay close attention to what the Fed says in its statement.
At its October meeting, policymakers said that the risks of inflation and economic growth were roughly in balance. If they stick to that same script, that could bode well for the dollar, said Nick Bennenbroek, head currency strategist at Wells Fargo Bank in New York.
"The key question is whether they feel comfortable or bold enough to repeat that assertion," said Bennenbroek. "If that statement is there, then we might see the dollar stabilize or even move higher."
Whatever action the Fed takes on Tuesday, there have been encouraging signs for the U.S. economy - a bullish indicator for the greenback.
Last Friday, the Labor Department reported that the economy added 94,000 jobs in November, while the unemployment rate held steady, suggesting that the U.S. economy was unlikely to enter a recession in 2008.
"I think perhaps there is a window here for the dollar to do a little better for the next few quarters," said TD Securities' Osborne.