Get ready for a dollar rebound

The weak greenback has hurt investors and consumers. But some see hope that the dollar will bounce back...which could mean relief on the inflation front.

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By Paul R. La Monica, editor at large

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NEW YORK ( -- There's a moderately amusing McDonald's commercial where office workers bemoan the moribund state of the dollar until they realize how much they can buy with a buck on Mickey D's dollar menu.

Yup, everybody is talking about the sad state of the greenback. The dollar's weakness has been bad news for consumers. It has driven up the price of commodities and that's sent food and gas prices sharply higher. Imported goods are now more expensive.

And that vacation you were planning to Europe? Good luck being able to afford a nice bottle of Bordeaux in Paris. (You might want to try these vacation spots where the greenback is still relatively strong.)

However, some see hope ahead for the dollar. For one, it has rebounded a bit against the yen after hitting a 12-year low against Japan's currency in March. And after hitting a record low against the euro yesterday, the dollar bounced back a bit against the euro Friday.

Market experts say this could be a sign that investors sense the U.S. economy may in fact pick up in the second half of this year. As such, it's hard to imagine the dollar falling much further.

"There is a universal despisement of the dollar. Everything negative about the U.S. economy is discounted. There are no secrets," said David Hoffman, managing director with Brandywine Global Investment Management, a fully-owned subsidiary of Legg Mason. "But I don't think growth will be as weak as the bearish case. The environment is set up for a dollar bounce."

The market also seems to be sensing that the Federal Reserve may stop lowering interest rates soon. That would also help strengthen the dollar since big rate cuts since last September are one reason why the dollar has fallen.

"Investors are reacting to the idea that the Fed is almost done or done cutting rates," said Bill Knapp, investment strategist with MainStay Investments. "There is continued inflation pressure. That's the biggest risk to the economy and the Fed knows that."

Bets on another steep rate cut at the Fed's next meeting at the end of this month are diminishing. According to federal funds futures on the Chicago Board of Trade, investors are pricing in a 100% certainty of a quarter-point cut on April 30 but only a 6% chance of a half-point rate cut.

If the Fed pauses after the April 30 meeting, that could put an end to the dollar's free-fall. And that could help consumers who have been hit hard by rising prices at their local grocery store and gas station.

"I think a stronger dollar will help knock oil prices down," Hoffman said. "The gut reaction for many investors in the past few months has been 'The dollar's weak. Buy something else.' Any strength in the dollar would help diminish intermediate inflation fears."

Hoffman said he's hopeful the dollar may have already bottomed out against the yen and may be in the process of doing so against the euro.

But what will it take for a meaningful rally in the dollar? Knapp says two scenarios could keep the dollar rallying. The first is that the European Central Bank, which has resisted calls for rate cuts, finally starts lowering rates. That would sap some of the euro's strength. Knapp doesn't see that happening anytime soon though.

The more likely situation, according to Knapp, is that the Fed cuts its federal funds rate to 2% at the end of this month, keeps it there for a while and then starts raising rates later this year as the economy picks up.

"Interest rates play an important role in where currencies go. A pause in the Fed's rate cuts would at least stop the fall of the dollar," he said. "And if the housing market comes back as I think it will this summer, there is a good chance you could get a rate hike before end of the year."

Hoffman is also optimistic that the housing market will stabilize soon. And he agrees with Knapp that the Fed is likely to hit the pause button once rates hit 2%.

But he thinks Europe will actually help the dollar as well since that central bank, which typically has a heavier inflation focus than the Fed, can't ignore the possibility of a slowdown in Europe for much longer.

"The ECB, before too long, will begin cutting rates. Economic reality will force them to. They tend to not focus on slowing growth until they have to," Hoffman said.

Hopefully, Knapp and Hoffman are right. A stronger dollar and the resulting dips in food and energy prices would be a welcome relief to all.

And hey, maybe a stronger dollar will cause a certain Brazilian supermodel - and girlfriend of Super Bowl-losing quarterback Tom Brady - to start demanding payments in dollars. Yes, I realize that the Gisele Bundchen only works for euro story turned out to be untrue but this Giants fan couldn't resist working in another mention to Big Blue's (not IBM) Super Bowl championship!

Issue #1 - America's Money: All this week at noon ET, CNN explains how the weakening economy affects you. Full coverage.

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