Little stands in the way of the US dollar next week closing out its best yearly performance since 2005, although the final few days of 2008 could feature some bumpy movements as trade thins out. Perhaps ironically, the dollar has been a prime beneficiary of the worst global financial crisis since the Great Depression, even though the United States arguably is at the center of the storm.
A global unwinding of risky trades, US repatriation of assets and safe-haven flows sent the greenback soaring for the better part of the second half of this year. While the rally has lost steam in the last few weeks, the dollar remains on track for a yearly gain of nearly 6 percent against a basket of currencies after a two-year slump of 16 percent.
Most major currencies will likely be confined to their recent ranges next week, although thin liquidity ahead of year-end and the New Year holiday could increase volatility.
"I would expect for the dollar to probably remain within familiar ranges as light conditions keep activity relatively subdued," said Omer Esiner, senior market analyst at Ruesch International in Washington. "There's the potential for some choppy, volatile trading. But overall, we'll probably close out the year within sight of where are now." US financial markets will close early on Wednesday, December 31 and remain closed on Thursday, January 1 for the New Year. Trading will resume on Friday.
A key risk for the market next week, traders said, is the possibility of currency intervention by Japanese officials. The country's exporters are feeling the pain from a stronger yen, which hit a more than 13-year high versus the dollar earlier this month. Speculation is high that Japan may take advantage of thin liquidity to increase the impact of yen-selling.
"The conditions are ripe for the (Bank of Japan) to intervene if they intend to do so. The markets are so thin right now that it would not take much at all to move dollar/yen materially," said Michael Woolfolk, senior currency strategist at The Bank of New York Mellon in New York.
"We think there's at least equal odds that we would see BoJ intervention and if they choose not to do it next week, they won't do it at all." Should Japan intervene in the currency market, the dollar could easily top the 100 yen mark, he said.
The yen outperformed the dollar in 2008, benefiting from a massive global unwinding of riskier trades funded by cheap borrowing in the Japanese currency. The dollar's near-19 percent drop against the yen put it on track for its worst annual performance against the Japanese unit since a 23.2 percent decline in 1987, according to Reuters data.
DOLLAR UPTREND INTACT: The euro is on pace to post a loss of nearly 4 percent against the greenback this year, while the British pound has tumbled roughly 26 percent, the largest annual decline since Reuters began compiling data in 1983.
Demand for the dollar fell in the final weeks of the year as safe-haven and repatriation flows dwindled and after the Federal Reserve slashed interest rates to virtually zero. The currency also came under pressure as investors booked profits on its sharp gains since summer. Still, analysts say a deepening global recession and further rate cuts by central banks around the world should continue to lend support to the dollar.
"We're going to see the market really come to terms with the looming global recession and that's going to ultimately drive yields abroad lower and see global interest rates converge around where US and Japanese yields are currently," Ruesch's Esiner said. "That will ultimately underpin the dollar into next year."
The economic data calendar next week is relatively light due to the holiday. Highlights include the S&P/Case-Shiller home price indices and consumer confidence on Tuesday, weekly jobless claims data on Wednesday, and the Institute for Supply Management's manufacturing index on Friday. Also on investors' radar screens is the possibility of the euro and sterling reaching parity after the pair hit a high of 95.78 pence on Friday.
"The pound will keep weakening, and we are within striking distance of parity with the euro. I wouldn't be surprised if we touch parity before the year end," said Daniel Katzive, global director for foreign exchange at Credit Suisse in New York.
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