It looks like it’s going to be another up day. We have good news from Johnson & Johnson (profits up 40%, more than expected) and manufacturing in the New York area rebounding surprisingly. The latter shouldn’t be such a big surprise. With the dollar so low, US exports are booming.

Actually, although many people expect the dollar to decline further, we’re not so sure. The US balance of payments is correcting in two ways. Not only through the lower dollar (making US products more competitive at home and abroad, so reducing imports and expanding exports), but domestic demand is reducing because the US economy is probably already in a recession.

Reduced domestic demand means that consumers and businesses alike spend less on goods and services, including those imported from abroad, further reducing imports. Sooner or later those improved fundamentals will be reflected in the exchange rate, and the dollar is way undervalued as it is.

This might not happen tomorrow or next week, for now, the trend is still pretty much down. But we think that, bar some other big financial crisis in the US, the dollar has not that much further to fall.

Apart from the US trade balance, another big factor in determining the fate of the dollar is what will happen to US financial markets. Here, the picture does look less rosy, I’m afraid. Inflation is, if anything, accelerating. This morning, last months producer prices were published, and they rose by 1.1%, a pretty alarming figure. The fall of the dollar itself contributes to that by making most imports more expensive.

And the US central bank, the FED is really not focused on inflation right now, contrary to it’s counterparts at the European Central Bank (ECB). This difference is partly a reflection of different economic situation (the European economies are performing a lot better these days), and partly a reflection of the different philosophies of those central banks.

There might come a moment that the US central banks will have to start worrying a little more about inflation.

Another big minus for the US markets is that the housing market doesn’t seem to have bottomed still. According to it’s most important observer, the American economist Schiller (he’s the one who called the housing bubble consistently over the past years), houses were, on average, 30% overvalued. They have fallen only about 8%.

Combine falling housing prices with more difficult credit (not withstanding a pretty drastic ease by the central bank, but the banking system is in no mood to lend easy money at present), and you have an explosive cocktail. We’re not calling the bottom yet for the US markets. Way too early to say.