Despite Fed Action, Dollar May Strengthen

The US dollar continued its selloff on Thursday, dropping to near $79 in the continued wake of the Fed's statement on Wednesday. With the Fed promising to leave interest rates near record lows for years, the dollar may have little strength in the coming months. Precious metal bulls may have enjoyed the move, as gold broke strongly above $1700 an ounce and continued to rally on Thursday, moving close to $1730. Given the Fed's stance, a strong dollar seems unlikely. Yet, despite the Fed's actions, the dollar could see remarkable strength in 2012. In Japan, for example, rates have been low for decades. Still, the yen remains a relatively strong currency—strong enough to force the Bank of Japan to intervene a few times in 2011, and strong enough to have Japanese manufacturing companies post gloomy outlooks in recent weeks. Many critics have argued that a lost decade could materialize in the US. In such a scenario, the dollar could stay strong despite low interest rates and climbing sovereign debt. Further, with the Eurozone crisis remaining unresolved, a dramatic event such as disorderly Greek default could lead to a sharp selloff in equity markets around the globe. The uncertainty produced by such an event could have market participants running back to the perceived safety of the US dollar—similar to the situation in 2008. Of course, economic growth could crush the dollar. If investors believe that their money could be put to better use elsewhere, they may move out of the US dollar and into riskier assets. In that case, interest rates could spike and the dollar could sell off. If growth is increasing and the Fed maintains its commitment to near-zero rates for years, the dollar could become especially weak, as inflation spirals out of control.