Dollar update: still very weak

Since mid-November, the dollar is up about 18% vs. the yen, down 2% against the euro, and up 5% against Sterling. But against a broad basket of currencies, the dollar is still very close to its all-time lows.

This chart shows the inflation-adjusted, trade-weighted value of the dollar relative to two baskets of currencies, as calculated by the Fed, as of the end of January. Take your pick: these are arguably the best measures of the dollar's effective value vis a vis other currencies.

Although there has been a lot of currency volatility of late, particularly in regards to the value of the yen, the dollar remains very weak from a long-term historical perspective. It is at least encouraging that on the margin, the dollar has been eking out some gains. By the Fed's broadest measure, the dollar's purchasing power relative to other countries is up about 4% from its 2011 low. My take on this is that conditions in the U.S. (e.g., fiscal and monetary policy, economic growth) haven't turned out to be as bad as the market had expected.

Once again, I think this is evidence not of increasing optimism, but declining pessimism. The dollar is still very weak, and that is a sign that there is lots of bad news still priced into the dollar.

From an investor's perspective, this argues against taking on significant exposure to non-dollar currencies, unless you are very bearish on the prospects for the U.S. economy. Foreign currencies on average are very expensive at today's levels.