Dollar 2010: Rate, Not Great, Expectations

You can stop worrying about the weak dollar—you can also stop hoping for a strong one.

Nick Ut / ASSOCIATED PRESS

Most currency market analysts expect the U.S. currency to build on its 5-percent December bounce, as traders continue to factor in a stonger U.S. economy and an inevitable Fed tighening. Beyond that, however, a lot depends on just how poorly things go for other major currencies, such as the euro, pound and yen.

"The dollar had become oversold," says Michael Woolfolk, senior currency strategist at Bank of New York Mellon. "I see this as year-end positioning with a little added move by speculators."

Woolfolk may be among the least optimistic about the chance of a strong dollar run in 2010, but that's a very relative statement. Most expect modest gains, but no one is expecting a strong, broad-based rally.

"The dollar is very low; it has to move up," says economist Robert Brusca, chief economist with FAO Economics.

In general, analysts expect the dollar to remain weak against the currencies of commodities-driven economies such as Canada, Australia and Brazil, while making gains against those of Japan, Britain and the European Union.

At the same time, after a multi-year bear market that took the dollar to record lows against the euro and parity with the Swiss Franc and Canadian Dollar, analysts say the worst is definitely over.

"There's been a sea change in sentiment," says Boris Schlossberg, of GFT Forex. "The whole thesis began to change when [Novermber] payrolls came out," he explains, referring to the Dec. 4 government report showing that the economy shed just 11,000 jobs, the least in almost two years.

"Fundamental factors will be more favorable for the dollar next year," adds Vassili Serebriakov, a currency strategist at Wells Fargo, which is among the most bullish on the U.S. currency.

Fundamental Case

Those fundmaentals turn on this oft-cited scenraio: The U.S. recovery will be swifter and stronger than that of most other G7 countries, prompting the Fed to tighten monetary policy first.

At the same time, the U.S. economy is expected to be less vulnerable to future credit market shocks, which will help remind investors of its traditional safe-haven status.

"Rates are going to follow what's happening in the economy," says David Pierce, director at GPS Capital Markets. "We'll see a little more strength short term, due to continuing economic problems overseas and the weakness in the price of gold lately."

Though the Fed is widely expected to raise the federal funds rate no sooner than mid-year, the central bank is likely to undo some of its non-traditional, quantatative easing measures sooner, perhaps as soon as the first quarter.

"One of the big hurdles is the exiting of the Fed from the MBS [mortgage-backed securties] program," says Jacob Oubina, a strategist with Forex.com. He and others suspect that such a move will add at least half a percentage point to mortgage rates.

"The Fed policy flooded the market with cheap-dollar liquidy," adds Serebriakov.

Though there's some concern that problems in the U.S. commercial real estate market could weigh on the U.S. economy, strategists say there's more potential for trouble abroad, which will provide consistent support for the dollar.

"People are beginning to get concnerned about the sovereign credit values in Europe," says Schlossberg. "Portgual, Greece, Ireland, Spain--all of those countries have massive budget deficits."

When debt and budget alarms went off  in Greece and Dubai recently, the message was loud and clear to some.

"A flight to quality [the U.S.]? I think there was probably some of that," says Brusca. "These are mini-events that remind people that there is still risk out there."

One final tailwind for the dollar is the apparent end of the gold rally, which during its heydey prompted many an investor to sell dollars to buy gold.