US Dollar Strength Forecast

Since 2001 the US Dollar has been in an extended downtrend against major currencies.

The two issues that fueled in large part the decline of the dollar, the massive trade deficit, and the massive fiscal deficits, are still with us. However, the fall of the dollar may have just about reached its maximum for this cycle.

The primary reason I say that is due to the financial storm that is brewing in the sub prime US real estate financing market. Foreclosures have already reached record highs with much more havoc to follow.

The exotic sub prime mortgage market is going bad in a major way as borrowers are unable to pay the much higher monthly payments on their housing loans as resets take place.

Many of these marginal at best borrowers were sucked into financing homes with ARM, adjustable rate mortgages, which offered low initial interest rate loans with low payments for the first couple of years. Many borrowers closed on these loans not fully understanding that in the near future their monthly payments would be reset to much higher levels.

The day of reckoning has already arrived for a few of these unfortunate borrowers and will arrive for many more as 2007 passes by.

The disaster in the sub prime lending market has already impacted some major lenders. HSBC has reported large losses and 23 lending instructions have filed for bankruptcy so far in 2007.

The implications for the US Dollar are this. As troubles mount in the sub prime lending market there will be a tremendous liquidity squeeze. While the US government will attempt to supply as much funding as necessary to head off a collapse of the US housing market the effort probably will not work.

Just as the lenders were so eager to make sub par loans during the boom times they will be frightened enough by market conditions they they will be afraid to make new loans or refinance old ones except for the most credit worthy of borrowers.

Interest rates will spike as a risk premium gets built into the rate structure. The dollar will follow interest rates higher as the US economy falls into a deep recession.

A deep recession will perversely help the US balance of payments problem as consumers cut back on their purchase of imported goods.

It is a strange world that we live in. As economic conditions in the US worsen , especially in the real estate market, look for Dollar strength. This will surprise many traders and most certainly confound many analysis.

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