Here we are. We’re a year from the top of the commodities bubble. That bubble spurred the wholesale dumping of the dollar on the presumption that inflation would permanently debase the currency and begin the demise of the global reserve system. In the intervening year we’ve seen the implosion Lehman and AIG, the crippling of numerous once-powerful UK and European banks and the unprecedented intrusion of government into markets. During that time, the dollar strengthened as deflationary forces required an overly-leveraged world to quickly slash the size of their balance sheets.
With hindsight we can see that the post-Lehman credit crisis began to ease in March of this year and both the global and US economies began to show signs of stabilizing around that time. Around the same time, the Fed began to aggressively implement a novel monetary policy never before tried on the scope and scale required to reflate an economy the size of that in the United States. That policy shift gave ample ammunition to those who have been making the case for years on end that the dollar is destined for disaster. And make the case they did. Sharp rebounds in equities and closing of credit spreads helped reduce the safe-haven demand for the dollar as well.
From March until early June, EUR/USD rallied from the 1.2450 area to 1.4337, retracing about half the stunning losses seen in the July -November 2008 period in which EUR/USD fell from 1.6047 to 1.2330.
As summer unfolds, we appear to be shifting phases once again, from the delevarging-deflation phase last fall, to the stability-reflation phases this spring to a wait-and-see phase over the summer with a great deal of uncertainty over when and how robust a global recovery we can expect. This uncertainty argues for a somewhat stronger dollar, on balance ,in my view.
IF EUR/USD reached 1.43 on the idea that the global economy had begun a sustainable recovery, the mixed evidence to the contrary in recent weeks (US unemployment, today’s fall in ZEW, China not aggressively stockpiling commodities any more…) suggests to me that on a fundamental basis alone, EUR/US should probably down shift toward 1.30/1.35 as the summer wears on.
