Video: The holiday rush of tourists

updated 12/6/2006 1:59:24 PM ET 2006-12-06T18:59:24

While you're out battling the crowds at the mall or shopping for hot toys this holiday season, what you're buying and how much of it could influence the dollar's future moves.

In addition to dictating the level of retailers' profits, sales volumes this Christmas could signal whether consumers once again are riding to the rescue of an economy that is showing signs of slowing dramatically. And that may have great sway over what the Federal Reserve decides to do with interest rates in the months ahead.

That matters for the dollar since its recent plunge largely has been sparked by fears that investors will cash out of dollar-denominated assets as U.S. rates decline and instead put their money into areas of the world where rates are rising.

For most of this year, the dollar's slide has been overshadowed by bigger financial-market news: The rally that boosted major stock indexes to levels not seen since the dot-com boom and the retreat in oil prices from the highs seen over the summer.

In recent weeks, however, the slumping dollar has become harder to ignore. The greenback has plunged to its lowest level in 20 months against the euro and is at 14-year lows against the British pound. So far this year, the dollar has lost nearly 7 percent of its value against an index of major foreign currencies, according to the Federal Reserve.

The Bush administration has shown no signs that it plans to do anything to stem its decline. The weak dollar helps to lower the huge U.S. trade deficit by making American goods cheaper and more competitive abroad and foreign goods more expensive here. But it also could boost inflation if the price of foreign-made goods rise in this country, something the Fed doesn't like to see.

A combination of factors are being blamed for the dollar's pullback. For one, there has been speculation that China may shift part of its $1 trillion foreign-currency reserves — the biggest in the world — away from the dollar and into other major currencies.

Improving business conditions in Europe, namely in Germany, are also helping drive up currencies there, as investors look to put money into markets where profit growth is picking up as opposed to the United States where it is expected to start slowing down.

But most importantly, investors see interest rates abroad rising. The European Central Bank has bumped up its key interest rate five times to 3.25 percent in the last year, and more increases are expected.

That counters the monetary policy currently embraced by the U.S. Fed, which has held short-term rates steady at 5.25 percent since August after raising rates 17 times in quarter-point increments over the last two years.

While the U.S. interest rates still yield more than those in Europe, the big question is how long that gap will last.

Major Market Indices

A growing consensus on Wall Street seem convinced that U.S. central bankers will cut rates during the first half of next year to offset weak economic growth. But that isn't a done deal given the conflicting data.

A report from the Institute for Supply Management on Friday showed that the nation's manufacturing sector contracted in November for the first time in more than three years. In addition, two reports tracking activity in October showed durable goods orders had their biggest drop in more than six years and the median home price saw its largest year-over-year decrease ever.

But inflationary pressures are still running "uncomfortably high," according to Fed Chairman Ben Bernanke. He noted in a speech last week his discomfort with elevated "core" prices, which exclude energy and food costs and are closely watched by the Fed.

As long as the Fed cites inflation as a concern, there is less of a chance that its policymakers will start cutting rates. And Bernanke, in his comments made Nov. 28, repeated the central bank's interest in keeping open the possibility of a rate increase down the road, if such action would be needed to fend off inflation.

"A failure of inflation to moderate as expected would be especially troublesome," he said.

That's why so much may be riding on this holiday season. The way Americans spend before and after Christmas — the busiest time for buying all year, contributing half of all sales at some retail chains — could be a deal-breaker for the Fed.

Should the shopping season turn out a bust, then the Fed might see that as a sign of consumer fatigue and choose to cut rates in an attempt to stimulate growth. That could hurt the dollar.

Should sales top expectations, rates may remain steady or go up to contain inflation. That could support the dollar.

Still, it's important to note that Fed actions don't always correlate with the direction of the dollar's every move. In fact, what the dollar does in the coming months also will play into the Fed's decision on interest rates. Most important, the inflationary risks that come from the slumping dollar can't be ignored.

The thing about the dollar is that it tends to move in waves — the gains as well as the losses can last for a while. Come January, the outcome of the holiday shopping season will be known, but the fate of the dollar might not be as clear.

Copyright 2006 The Associated Press. All rights reserved. This material may not be published, broadcast, rewritten or redistributed.

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