Robert Shiller told Reuters that he would not be surprised to see home prices fall another 10 to 25%. If Shiller is right in his prediction, that may be extremely bullish for the U.S. dollar as deflation ravages the economy.
Deflation means an appreciating dollar. Though investors may see falling housing prices as a negative for future economic growth in the U.S., and therefore the U.S. dollar, the dollar has the unique advantage of being the world's reserve currency.
If growth in the U.S. slows, as it appears to be doing, that may be likely to rally the dollar, like in 2008. If investors see weakness in the broader U.S. economy, they may flee to cash to shield themselves from taking losses in equities.
Of course, the Federal Reserve could have a hand in preventing this scenario from playing out. Though the Fed has thus far denied the possibility of a QE3, Chairman Ben Bernanke has shown his willingness to intervene in the market when deflation remains a risk.
Bullish: Traders who believe that Shiller is right and anticipate falling home prices might want to consider the following trades:
Buy PowerShares DB US Dollar Index (NYSE: UUP). UUP is a long play on the U.S. dollar.
Short SPDR S&P Homebuilders (NYSE: XHB [FREE Stock Trend Analys]. XHB attempts to return a value based on the performance of homebuilding companies.
Bearish: Traders who believe that Shiller is exaggerating the problem, or that Bernanke would step in to prevent such an occurrence, may consider taking positions in the following:
iShares Dow Jones US Real Estate (NYSE: IYR) is an ETF which attempts to return a value corresponding to the real estate market..
SPDR Gold Trust (NYSE: GLD) is long play on gold. If the Fed increases liquidity to prevent another housing slump, gold may rally.
