Dollar Breaking Down

This big news this week was that the European Central Bank (ECB) raised interest rates on Wednesday. While it was only a 0.25% increase, from a very low level (1% to 1.25%), it has had a big impact on currency markets. The euro has certainly gotten a big boost, and as a result, the dollar has been under renewed pressure, falling through an important technical level. The next critical threshold for the dollar is the low from late 2009, which is only another -1.5% from here. If that fails to hold, then the 2008 lows might come into play.

Why does this matter? Well, a falling dollar will only exacerbate recent inflation pressures. It will drive commodity prices even higher (since they’re priced in dollars), threatening the economic recovery. A lot of blame for the dollar’s weakness has been placed at the feet of the Fed. They currently aren’t even officially considering raising interest rates from their ultra-low level; instead, they’re still furiously pumping credit through their QE2 program.

Critics wonder about the necessity of such stimulus when the economy is supposedly almost two years into a new expansion. The Fed has countered that they’ll be able to successfully remove the excess stimulus when the time is right and prevent inflation from really taking hold. The action in the dollar seems to indicate that the market isn’t buying it.

Chart: Trade-weighted dollar index w/ underlying support levels