Monday, February 14, 2011

Interest Rates, GDP Growth and the Dollar

Let's start with these relationships

1.) The dollar's value increases when interest rates increase. The reason for this relationship is currency traders -- after purchasing a currency -- park their holdings in the new currency in an interest bearing account. While U.S. short term rates are still some of the lowest in the developed world, long-term rates are among the highest.

2.) The dollar's value increases as the economy improves. The reason for this is a growing economy attracts foreign investment -- outside investors want to invest in a winner. In addition, consider this story for the WSJ:

A newly resilient economy is poised to expand this year at its fastest pace since 2003, thanks in part to brisk spending by consumers and businesses.

In a new Wall Street Journal survey, many economists ratcheted up their growth forecasts because of recent reports suggesting a greater willingness to spend.

3.) It's also important to note the dollar is still a store of value in the commodities market and a safe harbor currency in times of trouble.

Given these three facts, it's important to remember that going forward, the dollar may have a floor underneath prices. This has bearish ramifications for the commodities markets.