Fed Unlikely to Do Treasury's Dirty Work on Dollar

If the Treasury won't do anything to protect the plummeting U.S. dollar, will the Federal Reserve? Judging by the stock market's performance Monday, the smart money thinks not.

The dollar crashed through record low levels vs. the euro Monday, even as the Dow Jones Industrial Average surged about 1% to an 18-month high of 9,965. All the action came one day before the Fed's policy-making arm meets to decide on interest rate policy Tuesday.

Both rock-bottom interest rates and a weak dollar have come to be viewed conventionally as near-term bullish for stocks, and it is safe to say Monday's market action suggests traders are optimistic neither is about to change. The Nasdaq added 0.6% to 1,949, while the S&P 500 added 0.7% to 1,069.

The Treasury has repeatedly professed a "strong dollar" policy this year but has done little tangibly to prevent the currency's depreciation. Back in January, Morgan Stanley economist Stephen L. Jen argued that Treasury Secretary John Snow had adopted a "de facto" neutral dollar stance in an effort to allow the dollar's value to correct vs. the euro and the yen. Jen also argued in May that until the euro/dollar exchange rate reached 120, no credible effort to stabilize the dollar would materialize.

Now that the euro's risen to about $1.22, Jen thinks other parties might be heard from. "The G3 likely will take action on the U.S. dollar," he said, referring to Japan, Europe and the U.S. Jen expects that the dollar could bleed as low as $1.25 per Euro before rebounding.

There are three things the G3 can do to bring the dollar back up. First, national treasuries could simply buy dollars in the open market. Second, central banks outside the U.S. could cut interest rates and/or the U.S. Federal Reserve could raise them. And third (and by far the least likely), the federal government could put its fiscal house in order and stop printing money to finance an expanding budget deficit.