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If the Fed Ignores Turkey the Dollar Could Implode

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Inflation in Turkey is up--way up--accelerating at a rate not seen in almost a decade.

The Turkish economy is presently considered to be vulnerable to a financial shock, as its current account deficit is massive. In an effort to prevent the Turkish economy from suffering a shock, the Central Bank of Turkey has raised reserve requirements and made lending more difficult.

That appeared to be working, as data from Turkey on Wednesday indicated that the central bank had succeeded in reducing the rate at which the Turkish trade deficit expanded.

The Turkish central bank had hoped that it could slow the economy without resorting to raising interest rates. With Friday's inflation data, that no longer seems like viable strategy. According to Bloomberg, inflation in Turkey for the month of May was at an annualized rate of 7.2%--a month-to-month increase of 2.4%.

The Bank of Turkey had hoped to keep the lira weak, but aggressive inflation might prevent the Turkish authorities from accomplishing that goal.

There might be something here for Federal Reserve Chairman Ben Bernanke. The Fed's last release of minutes indicated that the Fed hoped to keep interest rates low for an extended period, while using other tools like balance sheet contraction to keep the money supply in-check.

If the experiences of Turkey are any indication, the Fed could find its hand forced in the coming months. As Turkey shows, inflation can accelerate quickly and unexpectedly--economists' forecasts for Turkish inflation were nearly 2% lower than the actual data.

Traders looking to play a weaker dollar in anticipation of U.S. inflation might consider PowerShares DB US Dollar Bearish Index (NYSE: UDN). UDN attempts to return a value corresponding to the relative strength of the U.S. dollar and may rally if the dollar depreciates.

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