August 4, 2008 9:35PM

Has the Dollar Finally Bottomed Ahead of the Fed?

By Brian Sullivan

Below is a 1 year chart of the PowerShares Dollar Bull ETF (UUP).    The question ahead of tomorrow’s Fed meeting is if the U.S. dollar has finally turned from being the weak-back back into the trusty old greenback our grandfathers loved and respected.  The answer is a semi-affirmative “probably.”

The UUP is not a direct bet for the dollar against any one currency.  Rather it is a long bet for the dollar against the Yen, British Pound, Canadian Dollar, Swedish Krona and Swiss Franc.  The chart above shows that the UUP has tested the $22 mark five times and each time held, and held a little higher.   And it’s been doing so for more than four months.  Technicians might argue this ETF - and thus the dollar against those currencies - is looking for a bottom.

The key is “against those currencies.”   I would be wary of betting on a stronger dollar against many other world currencies, particularly growth currencies in Asia and the B.R.I.C nations.   But the European Union has its own problems.   Despite slowing growth, The European Central Bank and its hawkish leadership have maintained and aggressive stance against inflation.   The problem is that as the E.U. economy slows, it will be harder to for Jean-Claude Trichet and Co. to wax poetic on the inflation story and keep rates where they are.   As housing and consumer spending slows in Nice, Salzburg, Trieste and Estoril, the ECB will have to consider cutting rates to stimulate growth.  Sound familiar?  Its America, two years ago.   Remember disco didn’t rock Europe until a couple years after Xanadu was a hit stateside either.

Tomorrow the Fed will make its decision on interest rates, and its expected by everyone that there will be no change in the overnight lending rate.   The key is the brief statement the Fed makes along with the 2:15pm ET announcement.   Listen for any hawkish talk about inflation.   When (not if) we eventually see some stabilization in the credit and housing markets it’s likely Helicopter Ben will want to finally go after high gas and commodity prices.  And the central bank will do so with the best weapon it has: raising interest rates.  When interest rates rise, the dollar will likely strengthen.

Even if you don’t accept my inflation/Fed/disco argument, ask yourself this: if economic growth is slowing in 14 of the 15 Euro-zone economies, should the Euro really be worth 50+% more than the U.S. dollar.   We are weak, but we aren’t that weak.