Why the Dollar is Crashing Before the Fed Announcement

The US dollar broke out this week and is hitting multi-month lows against other major currencies. In particular the dollar is sinking when compared to "commodity" currencies like the kiwi (New Zealand dollar) and the aussie (Australian dollar). As reports continue to show improvements within the global economy and a Fed that won't raise rates investors are selling dollars to get into higher yielding investments. This selling may not impact the dollar's purchasing power immediately and it may actually benefit the economy further by making exports from the U.S. cheaper and more attractive to international buyers.

The U.S. dollar has two values. The first is its purchasing power. Inflation will hurt the dollar's ability to purchase goods while deflation will increase the dollar's purchasing power. During 2007-2008 there has been very limited inflation or disinflation, which can be dangerous if it turns into true deflation. The second way to value the dollar is relative to other currencies. Forex traders are constantly betting on or against the dollar versus the world's other currencies. In fact, 86% of all forex trades involve the U.S. Dollar.

One of the things that will impact the U.S. dollar's relative value against other currencies are trader's risk sentiment. When investors are very concerned about global economic risks it will gain in value as traders move into safer investments, which are often denominated in U.S. dollars. This shift of capital from risky assets to safer assets will affect the major stock indexes like the S&P 500 (.INX) and the Dow Jones Industrial Average (.DJI).

Stocks are considered a "risky" investment relative to Treasury bonds or other "safer" assets. This means that when traders get worried about risk, stocks will fall and demand for the U.S. dollar will rise. This is what we are seeing currently with a sinking stock market and a rising dollar. This inverse relationship may be useful to investors looking for diversification across asset classes. In the links below you can learn more about how to include the dollar in your portfolio even if you aren't a forex trader.