Monday, August 27, 2007

Rate Cuts = Stronger Dollar

Fed Ease Means Dollar StrengthRate
Increases have rarely constituted “tightening” when it comes to restoring the greenback’s value.
By John Tamny & Paul Hoffmeister

The Federal Reserve’s change in bias last week toward cutting the federal funds rate, along with its half-point cut in the discount rate, offers an opportunity to test the widely held belief that rate cuts weaken the dollar while exacerbating existing inflationary pressures. In truth, the opposite is typically the case, since dollar-demand shifts when the Fed acts.

Last week, the market response to the Fed’s new course was profound: Gold began a new short-term downtrend. The dollar adjusted for gold started a short-term uptrend compared with the euro adjusted for gold. The 30-year Treasury yield began a short-term downtrend. And the Russell 2000 Index — comprising small-cap companies and arguably the most sensitive equity index to monetary policy error — ended its recent short-term downtrend.

Overall, lower gold prices, a stronger dollar against the euro, lower long-term bond yields, and rising equity valuations are indisputable hallmarks of a disinflationary environment — not a resurgence of inflation........

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