US Dollar Bounces Back As World Economy Slows

By Jeff Cox
|  Wednesday, Jan 21, 2009  |  Updated 1:09 PM CDT
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The greenback is back—at least for now.

With a rapidly worsening European economy, a boost from the Barack Obama presidency and a craving for safety with at least some return, the dollar is riding a new wave of enthusiam among investors.

Though the rebound is expected to last at least six months, analysts caution that it could also end fairly quickly.

The dollar has been trading at its highest level against the euro in more than a month as bad news continues to pour in from Euro zone banks. Central banks are expected to take more aggressive moves to cut interest rates, weakening their currency even more  and boosting the dollar.

At the same time, a belief that the US economy—though still stagnating—is further along in the recovery process than its European and Asian trading partners is lifting near-term hopes for the greenback.

"We have a dollar bullish call at least through the first half of the year and maybe even longer," says Jack Crooks, who edits two investor newsletters for Weiss Research. "A lot of people have awakened to the idea that deflation is grabbing hold globally and this idea that inflation is a problem is really history."

A sharp decline in oil prices is another reason for the dollar's strength as demand from major consumer China slows. And the continued slump in US stocks and anemic yields from Treasurys are boosting the dollar as a safe-haven play that can actually generate some returns.

"The wheels are coming off in China and that's the driver of all things commodities," Crooks says. "The market in general is in trouble. People are just going to continue to move to cash in the short term. We see no reason any type of signs for a turnaround in stocks."

Indeed, the allure of the currency trade both reflects and foretells difficult days for stocks.

In tough times, investors will seek the best combination of safety and returns they can find. Stocks are providing neither at this point, and while government debt is safe there is little provision for returns.

Some question, though, how long the move to the dollar can last.

"It's a straight fear play, and that has to stop," says Michael Kresh, of M.D. Kresh Financial Services in Islandia, N.Y. "Eventually we have to recognize that the people who are putting their money in effectively a zero-interest environment with the recognition that not making money is better than losing money will also recognize that not making money is also a failure option."

But near-zero Fed interest rates will prevent the dollar from sustaining its gains long-term, says Kresh, who does see a rally lasting several months.

The dollar also could face pressure from the Obama administration's efforts to boost exports,  which gain when the US currency is weaker.

And a weak US economy,  even if it is marginally stronger than its competitors, will provide only limited solace over time to traders.

For Investors

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"The inauguration speech was uplifting and pride in America should certainly be on the upswing in the coming months and years," says Emily Sanders, CEO of Sanders Financial Management in Atlanta. "However, no one can erase all the stress that the world economy is under, and the US is accounting for less and less total GDP.

"It's still the leader but over time the trend is away from the US being the sole dominant economy. We're going to have to share our role with others. Even though currency exchange rates are most linked to interest rates, I do think that the country's position in the world does play into the psychological strength of the currency."

As such, Sanders isn't a believer in the dollar rally and is maintaining positions in large US-based manufacturers with a global reach.

Investment advisers are continuing to put the focus on being nimble, especially with trades that seem to have a relatively short shelf-life such as the dollar's current move.

"There appears to be globally the greater fear of being in another currency than in being in the dollar," Kresh says. "As long as oil prices stay low the dollar will stay strong. But I don't expect it to continue to appreciate."

For more stories from CNBC, go to cnbc.com.

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