The dollar may retreat slightly from multi-month highs against the yen and euro next week as trading volume dries up and markets look to 2010. The fate of the US currency once January arrives, however, is an open question, and investors will look to see if the greenback's impressive December rally turns out to be the start of a trend or simply a seasonal anomaly.
This year was not a kind one to dollar bulls, who saw the currency battered on the view that the Federal Reserve would hold interest rates at record lows for some time and the United States would lag recovery elsewhere in the world. But over the last month, markets have questioned that forecast, thanks partly to strong US employment and consumer data and Fed plans to wind up most emergency lending programs by February.
While rates are seen on hold until the second half of 2010, many now think the Fed may move more swiftly than the Bank of Japan, which is wrestling with deflation, and the European Central Bank. The dollar has rallied sharply in December as a result, nearly halving its year-to-date losses against major currencies.
Scotia Capital strategist Camilla Sutton said the frenzy to cover dollar shorts seen over the last three weeks may be over, which could set the greenback up for a mild retreat next week. It rose to a 3-1/2-month high against the euro and 2-month peak against the yen this month.
"In the long run, the dollar is still in the midst of a multi-year decline and I think we'll close 2010 at lower levels than we're at currently," she said. For now, though, she said worries about sovereign risk in Greece and other euro zone countries and stronger US data have created "a sea change in sentiment on the euro" that will take some time to reverse.
The US Treasury's plans to auction $118 billion in new debt will be the main event for the market next week, and analysts said any sign of weak demand could sting the dollar. "It's unclear yet how robust demand is going to be, as it's a holiday week and a lot of hedge funds have stepped to the sidelines until the new year," said Brian Dolan, chief strategist at Forex.com in Bedminster, New Jersey. "The risk is that demand is on the weak side and that dents the psychology of the dollar even though it will send US yields higher."
Jens Nordvig, a currency strategist at Nomura, said it's still hard to make the case that the outlook has changed in such a way that warrants a long run of dollar strength. "First, we think US monetary policy will remain extremely loose in 2010," he said. "Second, we think the underlying foreign demand for US assets remains structurally weak." In a note to clients, he said the bank is considering a fresh short-dollar position, though he cited a euro decline to its 200-day moving average around $1.4193 as the main risk to such a trade.
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