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Exploring the Dollar's Disconnect

While stock index futures remain on a roll, dollar index futures languish. What gives?
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Talk about a disconnect: Stock index futures have been on a roll, but the dollar gets no respect.

In six weeks, December

S&P 500

(SPZ2:CME) futures are up 17%,

Dow Jones Industrial Average

(DJZ2:CBOT) futures are up 23%, and

Nasdaq 100

(NDZ2:CME) futures are up a whopping 40%. Meanwhile,

dollar index futures

(DXZ2:NYBOT) are languishing, down 2.5% over the same period. What gives?

We may have to look no further than the government's balance sheet to understand why the dollar is being held in check. Last month, the

Treasury Department

reported the government posted a $53.99 billion budget deficit, the largest ever for the month of October. This compares with a $7.66 billion deficit from the previous October.

Now, with a Republican-controlled


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, there's no budget relief in sight for what appears to be a don't-tax-and-spend GOP economic agenda. Consider what's coming down the pike: We have significantly higher payments for homeland and international security. War with Iraq would likely bolster international security, but the invariably expensive tab will largely be borne by the U.S.

The Bush economic team is considering, among other proposals, enhancing and extending depreciation write-offs granted to businesses last March. This break lets businesses depreciate many new equipment purchases up to 30% in the first year. While the administration is keeping quiet about specifics, momentum is building to increase the first-year write-off, to extend the deduction beyond its 2004 term or both.

This is just one example of the fervor to cut taxes to stimulate the economy. Other tax cuts to businesses are in the works. And efforts to reduce taxes to individuals appear to include moving up to next year a cut to families, tax refunds for low-income folks, relief from the marriage penalty and raising the child tax credit. Such breaks for low- and middle-income Americans should get filibuster-threatening Democrats on board for the rest of the Republican tax agenda.

In the long run, tax cuts stimulate the economy by enhancing capital formation, investment and consumer spending. But in the short term, they drain government coffers and increase budget deficits, a downer for the dollar.

If you're waiting for the dollar to confirm the rally in equity indices and futures, don't -- at least not until the tax cuts have had more time to trickle through and stimulate the economy.

The End of a Multidecade Trend?

If you've looked at a continuous chart of T-bonds, you might have noticed they've had a spectacular, multidecade run, which hit a 41-year high last month. The


recent aggressive 50-basis-point rate cut as well as the accompanying

policy statement that the risks between inflation and economic growth are "balanced" suggest the Fed is done easing and that a reversal of the macro trend is at hand.

Two factors on the December


(USZ2:CBOT) charts are also providing clues the trend is over and a defined-risk level to test the theory that the near-half-century rally in bonds is over. On the following weekly chart, notice that the latest down stroke in T-bonds was its biggest price overbalance of the current contract.

Switching to the daily chart, notice that after the recent downdraft, T-bonds quickly recaptured -- but held below -- the 78.6% retracement of the price overbalance. This action is indicative of a last-gasp test of the high. The 78.6% level at 113 20/32 should contain additional rallies and serves as a stop-out point for short players looking for levels to capitalize on the end of a major trend.

Marc Dupee is an independent trader and co-author of the book

The Best: Conversations With Top Traders. Dupee was formerly markets analyst and futures editor for TradingMarkets Financial Group. At time of publication, he held no positions in any securities mentioned in this column, although holdings can change at any time. Under no circumstances does the information in this column represent a recommendation to buy or sell stocks. While he cannot provide investment advice or recommendations, he invites you to send your feedback to

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