Dollar on path for a crisis

A lack of words can speak a lot louder than the words themselves.

The currency market can be very frustrating for traders, because it doesn't always follow a clear fundamental logic. It can rise and fall in unison with bond yields, but also with bond prices; it can fall on a widening trade deficit, but it can also rise if that deficit is expected to lead to increased pressure on politicians to act.

It can also fall when the U.S. says, and when it doesn't say, it has a strong dollar policy.

The dollar is moving toward a crossroads. The U.S. Dollar Index, which tracks the buck against a handful of the world's major currencies, has been consolidating along an uptrend line that began in December 2004, but also along a downtrend that started in November 2005.

Given that the trendlines are on path to intersect, the dollar will be breaking out soon. Technically speaking, it looks very likely that the direction will be to the downside.

With China and other countries freely talking of plans to diversify their foreign exchange reserves, which have been predominantly comprised of U.S. dollars, the FX hordes now have a fundamental excuse to push for a breakdown.

That would certainly run counter to the U.S.'s stated "strong dollar" policy at a time when a weak currency is certainly not necessary. If new Treasury Secretary Henry Paulson, Jr. doesn't want to deal with another currency crisis, like his ex-Goldman Sachs predecessor did more than a decade ago, he should realize that it takes more than a few unspoken words to turn a $3 trillion-a-day foreign exchange market.