Why the Dollar's Back

Alan Greenspan may find it painfully puzzling that the Federal Reserve's interest rate increases, which have taken short-term rates from 1% in June 2004 to 4% currently, haven't pushed up long-term interest rates significantly.

But at the Nov. 10 close of 4.56%, the yield on the U.S. 10-year Treasury note was significantly higher than investors collect on either European or Japanese bonds. That day, the 10-year German bond was yielding 3.51%, and the Japanese government's 10-year bond was paying 1.57%. (The U.S. bond market was closed on Nov. 11 for Veterans Day.)

Any wonder, then, that the U.S. Treasury's auction of 10-year notes on Nov. 10 was massively oversubscribed, with $29 billion in bids for the $13 billion in bonds offered? If foreigners are so willing to buy our IOUs, why is the size of the trade deficit something to worry about? Pretty much sums up the attitude on Wall Street.

3) High oil prices aren't just a problem; they're also a solution.

High oil prices added about $1.5 billion to the trade deficit in September, even as the volume of imported oil dropped by about 2%. The U.S. imported about $23.8 billion in petroleum and petroleum products in September, according to the Bureau of Economic Analysis report. That put a lot of money in the hands of Middle Eastern central banks and investors, who immediately put those dollars (remember, oil trades in dollars) to work earning interest by buying dollar-denominated assets such as Treasury bonds.

The future is likely to bring major changes in direction to all three of the trends now driving the U.S. dollar higher against the euro and the yen. The shift is likely to be gradual. But by mid-2006 -- six to nine months from now is a reasonable time frame -- we're likely to see the dollar in at least modest decline against both the euro and the yen.