The dollar on the comeback trail

Even though the Fed's inflation talk wasn't as tough as some had hoped, the greenback is rallying against the euro. And it could strengthen even more.

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By Paul R. La Monica, editor at large

The dollar (in yellow) has strengthened against a basket of global currencies in the past month as oil prices (in blue) have fallen.

NEW YORK ( -- The Federal Reserve sent a strong signal to the markets on Tuesday that it would not be raising rates anytime soon, and you'd think that would spell disaster for the dollar.

Low rates in the United States versus Europe push funds into the euro and out of the dollar.

Yet, the dollar was up against the euro and yen on Wednesday, and even hit a seven-week high against the euro and seven-month high against the yen. The dollar has gained nearly 4% since hitting an all-time low against the euro last month.

To quote Lewis Carroll's Alice, "Curioser and curioser!"

So can the greenback continue its little rally? Some experts think that will be the case. And there are two good reasons.

One is that there are growing signs of global economic weakness and easing inflation - both of which should keep the dollar from falling.

Most important on that score is that oil prices are finally falling. The weak dollar had been one factor in rising oil prices. But now that oil prices are on the decline, inflation pressures are easing somewhat.

"The reason oil prices have been high is that as the dollar has weakened, oil producers have had to mark their prices up so that profits don't deteriorate," said Arun Raha, senior economist with Swiss Re.

Another sign of easing pricing pressures is gold, a classic inflation hedge. The metal has fallen back below $890 an ounce after flirting with cracking the $1,000 barrier last month.

"Weaker global economic growth will undermine commodity prices for the foreseeable future," wrote Stefane Marion, an assistant chief economist with National Bank Financial in Montreal, in a report yesterday afternoon following the Fed meeting.

Marion added that the dollar "will normally thrive during a correction in commodity prices" and that this decline, "combined with waning pessimism about U.S. financials... should renew investor's interest for U.S. assets that have been severely depressed."

"There are yet better days ahead for the U.S. dollar," Marion wrote.

A second case for a firming dollar is that European economies are finally starting to slow down, as I predicted several months ago.

With that in mind, the European Central Bank, despite raising its own benchmark interest rate just last month, may now have to also abandon its hyper-vigilant inflation stance and concentrate on weaker growth trends.

If it eventually cuts rates, that would reduce some of the allure of the euro relative to the dollar.

In a note to clients Wednesday morning, Ashraf Laidi, a currency strategist with brokerage firm CMC Markets US, wrote that ECB president Jean-Claude Trichet may "stress the downside risks to the Eurozone economy" in a press conference on Thursday.

Of course, the dollar still has a ways to go before it can be considered a truly strong currency compared to the euro, yen, British pound and others. But you have to like the current trend.

Swiss Re's Raha thinks the dollar could gain nearly another 10% against the euro by the end of 2009.

"I see the dollar strengthening against the euro over the next year to year and a half because growth in Europe will slow more than it has in the U.S.," he said. "Currencies typically overshoot. It's going to have to correct."

And David Joy, chief market strategist with RiverSource Investments, argues that the dollar could gain another 15% to 20% against the euro over the next year. That's because he believes that the ECB may have to cut rates next year and that the Fed may start to raise rates sometime in early 2009.

"The dollar has been way undervalued for some time and it could keep rallying, especially if the Fed starts hiking rates," he said.

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

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