The dollar has long been in a bearish trend, but shot higher on May 4, 20011, after key monetary policy meetings in Europe. The European Central Bank (ECB) and Bank of England (BOE) both held short-term interest rates steady in May. Many market participants were expecting rate increases and were caught off guard, and most commodities, priced in U.S. dollars, headed south. However, I am not convinced this means the end of the longer-term trends in the dollar and commodities.

At the U.S. monetary policy meeting in April, Federal Reserve Chairman Ben Bernanke did something that was quite historic—he spoke with the press following the April 26-27 Federal Open Market Committee meeting. This has never happened, and it was done in the effort of transparency. He conducted this session to help the public and the markets better understand the thinking behind the Fed’s decisions.

Why does the Fed move interest rates move up or down? One reason would be inflation, or the lack thereof. The Fed seems less concerned about inflation than its central bank counterparts in the rest of the world. In its April FOMC meeting statement, the Fed said “inflation has picked up in recent months, but longer-term inflation expectations have remained stable, and measures of underlying inflation are still subdued.”

The U.S. Federal Reserve is stimulating the economy and attempting to stimulate spending and growth though easy monetary policies. The Fed feels as if the U.S. economy is fragile, mainly due to weakness in housing and employment. Meanwhile, Europe is worried about inflation. India is worried about inflation. China is worried about inflation. Canada and Australia are worried about inflation. It seems early all the world’s economies are worried about inflation, and their central banks are reacting by increasing interest rates and/or engaging in other tightening measures. Not in the U.S. Our key short-term lending rate (the Fed funds rate) remains near zero and the Fed continues to pursue the second phase of quantitative easing regime known as “QE2.” These disparities in policy have had a big impact on the dollar and other markets.

After its scheduled policy meeting on May 5, the European Central Bank decided to keep its key short-term interest rate steady after boosting the rate a percentage point to 1.25 percent in April. ECB President Jean-Claude Trichet implied the bank would wait until after June to raise interest rates again, but added, “we are never pre-committed and we can increase rates whenever we judge it appropriate.”

Some investors and traders were thinking a rate increase would come sooner from the ECB, causing the euro to plummet versus the dollar. Most commodities, which are priced in dollars, took a hit. We saw price destruction take place, particularly in silver. The all-time “Hunt Brothers” high for silver in 1979 was $50.36. On April 25, silver hit $49.84, less than a dollar away. Silver just couldn’t get there and fell to under $38 an ounce.

I think that despite after the dollar makes a corrective run higher, it will return to a bearish trend. Traders should keep an eye on 70.80 in the June U.S. dollar index futures contract, which is the low from March 2009. If the market falls under that level, it’s a big deal.

The dollar has been in a bearish trend for more than a year, and I don’t see any evidence that trend is changing yet. I expected a decent U.S. April employment report (nonfarm payrolls rose a larger-than-expected 244,000), but I don’t think that will change the dollar’s bigger-picture trend as long as the Fed remains on hold, and other nations’ central banks pursue tightening policies. Of course, the picture could change, but I don’t see anything on the charts that will tell me the strong commodity/weak dollar trend is reversing.

These are my general thoughts and trading ideas at this point in time, and not to be taken as specific trading recommendations. These ideas may change at any time as conditions change in the markets.  For more specific strategies tailored to your unique risk tolerance and goals, I encourage you to contact me.

Jeff Friedman is a Senior Market Strategist with Lind Waldock. He can be reached at 866-231-7811 or via email at jfriedman@lind-waldock.com. Listen to more comments from Jeff on this topic in a webinar conducted May 4, 2011. http://lind-waldock.adobeconnect.com/p58122152/

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