US Dollar

The dollar dropped sharply in FX late last week, reflecting
a sharp rise in the Fed's portfolio through repo activity.
The primary dealers who handle FOMC orders are also major
FX market makers. So, the dealers are anticipating the Fed
will now go on to provide additional, needed liquidity for the
holiday season. I have pointed out over the course of the
year that the Fed would need to be poised to provide
liquidity should business credit demand fall off. Now
data show a flattening in mortgage generation and a sudden
$12 billion dip in C&I loan demand. In addition, currency
and checkables in the system have been running at low levels.
To round out the preamble, dealer FX earnings help pay the rent,
and dealers count on some volatility in the dollar to make it
happen. Dollar volatility has been restrained this year until
lately, and the dealers are pushing their advantage.

At present, the Fed, as most economic observers, sees slow
economic growth in this quarter followed by a recovery back
to 3.0 - 3.5% growth as 2007 progresses. Moreover, since
there has not yet been a decisive break in the uptrend of
inflation less commodities prices, the Fed may provide seasonal
liquidity for the current holiday season in as measured a fashion
as it can.

The dollar is headed to oversold levels, but it can clearly go
lower. In fact, at 83 and change, the $USD is only a tad over 3
points above major long term support at 80. I do not have a
strong view of whether the dollar will fall to long term support,
but I suspect if it does, the test would receive tremendous
attention, as a decisive break below support would excite traders
and foreign holders of dollar denominated assets. For a $USD
chart, click here.