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Dollar Rebounds From Thrashing

New record lows in Asia have been followed by new highs.

In dramatic but thin price action, the dollar slumped in Tokyo-less Asian activity, falling to JPY107.55 as the euro rose to new highs, just shy of $1.4970.

No fresh fundamental developments seemed to have triggered the move, but there are continued fears that the distress in the credit markets will force the


to continue to ease monetary policy. However, just as inexplicably, the dollar rebounded in late Asian trade and has continued to recover through the European morning.

Technically, the euro appears to be posting a key reversal, setting new record highs and then selling off below yesterday's low. However, given the thinness of the markets, we'd place more importance on Wednesday's low of about $1.4776 as important today. The Swiss franc is also staging a potential key reversal, but like the euro, Wednesday's low near CHF1.1080 may be more significant than yesterday's CHF1.1040 low. Sterling has also reversed, and Wednesday's low was set just below $2.0530.

The dollar has recovered off its lows against the yen, but is struggling to re-enter yesterday's range, the low of which was recorded near JPY108.30. In general, while wanting to respect the price action, I am reluctant to read too much into it at this stage and am not convinced the underlying trends have reversed.

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It is difficult to find much rhyme or reason in today's wild price action in the foreign exchange market. I am inclined to dismiss it as a fluke recorded without much participation. However, it may provide a good opportunity to sum up our outlook. The main weight, in my view, on the dollar is not structural concerns, which in the vernacular of the marketplace includes the current account deficit, the dollar's role as the numeraire for the world economy and its status as the predominant reserve asset. Instead, I see the weakness as largely cyclical in nature, having to do with the divergence in the monetary cycles among the major industrialized countries.

In terms of both duration and magnitude this bear market does not appear unusual. Even some of the anxiety over its decline and the existential angst expressed in some quarters is vaguely reminiscent of the mid-1990s, the last time the dollar was setting record lows against the then Deutschemark.

I had expected an acceleration of the dollar's losses into the end of the year on the back of our understanding of the trajectory of policy -- i.e. Fed rate cuts -- and the microstructure of the market, which I understood to provide many market participants little incentive to fight the dollar's powerful downtrend. We see the dollar as having been punished for the Fed's pro-growth policy thrust, but expect that other countries are as little as four and as much as nine months behind the U.S. in the credit cycle.

And as other countries cut interest rates, we look for the dollar to stage a more sustained recovery. We have identified the Bank of England and the Bank of Canada as the candidates most likely follow the Fed, with the ECB not cutting rates until late in the first quarter or the second quarter of 2008.

Marc Chandler has been covering the global capital markets in one fashion or another for nearly 20 years, working at economic consulting firms and global investment banks. Currently, he is the chief foreign exchange strategist at Brown Brothers Harriman. Recently, Chandler was the chief currency strategist for HSBC Bank USA. He is a prolific writer and speaker and appears regularly on CNBC. In addition to being quoted in the financial press, Chandler is often a guest writer for the Financial Times. He also teaches at New York University, where he is an associate professor in the School of Continuing and Professional Studies. While Chandler cannot provide investment advice or recommendations, he appreciates your feedback;

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