It is true that the general outlook is that the US dollar was the “scapegoat” of the forex market in 2009. However, on closer inspection, we notice that the US dollar actually strengthened against some currencies.

As the most traded currency in the world, it is important that we understand the behavior of the US dollar a little more.

In the current economic climate, the US dollar strengthens in two ways:

1) Good US economic data

2) Bad news affecting the world

Interestingly, in the last month and a half BOTH scenarios have played out:

Good US economic data

In the first week of December 2009, traders around the world were expecting to see the Nonfarm Payroll numbers. The expectations were high. In fact, traders around the world expected the figures to be between 125K and 135K. Upon release, the 11K job cuts “outperformed” even the most optimistic estimates. This feels the dollar on a rally.

In addition, recent jobless claims data showed jobless claims for the first time fell to the lowest level since July 2008 last week, as US businesses backed out of additional cuts at the end of the year.

Bad news affecting the world

The recent news about the possible default of billions of dollars from Dubai World shocked the world markets. That episode saw the US dollar strengthen against most major currencies. The reason is attributed to the “safe haven status” of the dollar, which causes traders around the world to “sell first, buy dollars and think later.”

More recently, credit rating downgrades for countries like Ireland, Spain and Greece have certainly helped the dollar extend its gains.

close of 2009

Towards the end of 2009, it seemed that the US dollar had “turned around” with its impressive gains. However, it would be wise to note that what happened was a typical scenario in year-end trading. Most traders and fund managers tend to close their positions for the year-end holidays; leaving little activity in the Forex Market.

Therefore, with low liquidity, any large order would cause significant volatility swings. Also, at the start of the new year, many US dollar contracts that support the US dollar rally earlier this year are reset.

Dollar strength for 2010?

My overall sentiment for the US dollar in 2010 is mostly bearish against the other major currencies. To be sure, Bernanke and Geithner have repeatedly spoken out that they “support a strong dollar.” Furthermore, recent data seems to justify that the dollar has turned around.

However, on closer inspection, the recent strength of the dollar is not supported by fundamentals. Unemployment and budget deficits are at record levels and home prices continue to fall. Debt has also shot through the roof with the government’s massive stimulus spending.

Will things get better? I’m sure.

In fact, based on federal funds futures, the market is currently pricing in a rate hike from the US central bank in the second half of this year. There is currently a 57% chance of a rate hike at the June meeting, followed by an 80% chance of a hike in August.

However, in Forex, it is always a game of “one currency against another”. The probability that other currencies will outperform the dollar in 2010 remains.

In summary, the dollar’s strength will continue temporarily, but as risk returns, the dollar will exhibit inherent weakness against other major currencies for most of 2010.

These include the euro (EUR), the Swiss franc (CHF) and other commodity currencies such as the Australian (AUD), the kiwi (NZD) and the Canadian dollar (CAD).

Asian Currencies Outlook in 2010

In general, traders will continue to spot signs of dollar weakness and capitalize on returns in emerging markets and Asian currencies in 2010.

By 2009, many Asian currencies outperformed the dollar:

1) Indonesian; Rupee: 16%

2) South Korea; Cattle: 8.9%

3) India; Rupee: 4.4%

4) Thailand; baht: 4.1%

5) Singapore; Singdollar: 3.1%

6) Philippines; Weight: 2.8%

7) Taiwan; dollars: 2.6%

The Asian dollar index, which tracks the region’s 10 most active currencies excluding the yen, rose 3.1 percent in 2009.

Asia’s comparatively higher interest rates and bond yields have helped attract global funds into fixed income assets. As an example, Indonesia’s benchmark rate of 6.5 percent compares to zero to 0.25 percent in the US and 1 percent in the euro region.

Not surprisingly, traders continue to “finance carry trades” with the weak US dollar.

Porcelain

This article would not be complete without talking about China. The argument that China helped the world out of recession is a foregone conclusion. With impressive economic numbers, the latest of which the manufacturing PMI hit an all-time high, China will continue to be the engine of global growth.

As for its currency, China is in no rush to appreciate its yuan, despite numerous calls from world leaders for it to do so.

In China’s current economic condition, the nation would likely consider the following 5 factors before considering yuan appreciation:

1) Consecutive quarters of increase in employment figures

2) Consecutive quarters of GDP growth

3) Exports on the rise

4) Increase in domestic consumption

5) When high inflation becomes a problem

Any early appreciation of the Yuan could derail sustainable economic recovery by attracting “hot money” and ultimately causing inflation.

The good news, however, is that senior Chinese officials are indirectly expressing their concerted intentions to gradually intensify monetary policy tightening.

Therefore, by the end of 2010, the yuan should appreciate between 2% and 3% against the dollar.

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