Things have turned ugly for the dollar again.
As I told you on Monday, the dollar has been enjoying a short–term rally…rising against other world currencies.
But this came to a screeching halt this morning following some dog-ugly data releases yesterday about the state of the U.S. economy.
News broke that residential construction was down 23.9% last month compared to a year ago – the largest decline since October 2009.
And as if this wasn’t bad enough, the Fed revealed that industrial production in the U.S. has stalled.
Quite honestly, I don’t blame the dollar bears. The U.S. economy remains weak. And the weaker it is the more inclined Ben Bernanke will be to continue his “quantitative easing”…and the less inclined he’ll be to raise interest rates anytime soon.
And longer term, unless Washington reins in spending, reduces its reliance on debt and carries out serious social welfare reforms, the dollar is doomed.
But the dollar now faces a new external threat – one that could see its value drop even faster than the most pessimistic dollar bears expect.
You see, one of the forces propping up the dollar has been the desire of emerging markets to keep their currencies low in U.S. terms.
The emerging markets want to keep their exports to America cheap. And to achieve this, they have been buying massive amounts of dollars and U.S. government bonds.
There’s only one problem: rising inflation. This is poses a huge threat to fast-growing emerging economies such as China, India and Brazil. And in response, these places have started to let their currencies rise versus the dollar as a tool to tame inflation.
As a result, the emerging markets can be no longer relied on to keep propping up the dollar.
This is bad news for emerging market exporters. Because a higher yuan, ringgit, baht or real compared to the dollar will make Chinese, Malaysian, Thai or Brazilian exports more expensive for American buyers.
But the emerging markets have little choice. They have to try to cap inflation somehow. And the most straightforward route is to raise interest rates and let their exchange rates rise relative to the U.S.
I saw this firsthand on my recent trip to Brazil. In one hotel where I stayed they had a chalkboard to show the Brazilian real to U.S. dollar exchange rate. When I asked the girl working in the reception why they had a chalkboard instead of a fixed rate, she told me that they had to switch to a chalkboard so they could keep pace with the rising local exchange rate. Recently, the real has been on a rocket ride against the dollar, much to the dismay of Brazil’s exporters.
The opportunity here is obvious: Sell dollars and buy emerging market currencies.
Faced with the choice between devastating inflation and a rising currency, the emerging markets will choose a stronger currency, which they rightly see as the lesser of two evils.
My favorite way to play the strength in emerging market currencies is through the WisdomTree Dreyfus Emerging Currency Fund ETF (NYSE:CEW).
This offers exposure to a basket of emerging market currencies, including the Mexican peso, Brazilian real, Chilean peso, South African rand, Polish zloty, Israeli shekel, Turkish lira, Chinese yuan, South Korean won, Taiwanese dollar and Indian rupee.
As well as reflecting appreciations in these currencies relative to the buck, CEW seeks to deliver money market rates available in these economies. These are considerably higher than comparable yields in the U.S. and other developed world economies.
If you haven’t already, consider adding CEW to your portfolio. It’s another great dollar diversifier…and it should see big gains going into the second half of the year as the emerging market currencies continue to rise against the dollar.