The weak dollar/strong stocks feedback loop is still alive and well

10/23/2009 10:30 am EST


Jim Jubak

Founder and Editor,

The U.S. dollar traded to another low and stocks rallied.

What else is new?

This feedback loop has been locked into place for months and it's showing no signs of taking a vacation.

Here's how it works.

A falling dollar leads to increases in the price of commodities, commodity-exporting country currencies, and commodity stocks. That pushes stocks higher in general.

As stocks climb, investors feel they can/must take on a little more risk. So they sell U.S. Treasuries, the safe alternative when equities and the world in general is looking a little shaky.

Selling those dollar-denominated Treasuries puts a little more downward pressure on the U.S. dollar.

Which pushes commodity prices, commodity-exporting country currencies, and commodity stocks higher, taking stock markets in general higher. And increasing investor appetite for risk.

This loop goes on, in my opinion, until we get either some currently unpredictable scary event that chases money back into Treasuries or until the Federal Reserve signals that it's ready to raise U.S. interest rates. That move from the Fed would potentially strengthen the dollar.

The first, the unpredictable scary event is, well, unpredictable. The second, an interest rate increase from the Fed, doesn't look likely in the first half of 2010.

Meanwhile the dollar is trading near a 14-month low against the euro and it set to turn in its third straight weekly decline against that currency.
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