As expected, after the announcement of the Fed’s new $600 billion bond purchase plan to boost the U.S. economy, the stocks and commodities were driven higher while Euro appreciated further partly reflecting European Central Bank decision to keep the interest rate unchanged. In fact the global stock indexes touched two-year highs while crude oil almost kissed $90/- per barrel and gold zoomed to record highs. Overall, the investors rejoiced the extra liquidity in the system.
And the dollar touched its 11 month low. Wow! that was too much, for China, who views the depreciation of dollar as indirect yuan appreciation. China came out with the most severe criticism and its 'government sponsored' rating agency downgraded US rating. That is China's way of thanking US companies who exported most of the manufacturing jobs to China, making millions of Americans unemployed.
But within a week's time, the dollar began to strengthen while commodities stagnated or dropped. Why? The major reasons are:
1. The market might have over adjusted to the anticipated announcement and now correcting itself.
2. One of the trader’s rules "Buy on rumour and sell on news" may be playing out.
3. Dollar is not only the currency of the US, but also the reserve currency of the world.
4. Many emerging economies have conducted studies and taking steps to control the dollar flow into their economies.
5. Unwinding of a portion of the USD based carry trade after the stock markets touched recent two year high.
However, in the long run, as more and more tranche of USD 600 bn hit the market, the possibility of depreciation of USD cannot be ruled out. One of the studies has indicated that over the next one year dollar can lose as much as 20% of its value.
But as economists say, this will happen ‘only if other things remain the same’. In this current volatile environment, we have to wait the reactions of other nations, who may view this as a step to weaken dollar. Moreover, the bad experiment called Euro is at the mercy of several fringe nations of the European Union. Any crisis for Euro will cause flight to safety causing USD to appreciate.
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